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Freescale Semiconductor Inc. (NYSE:FSL)

Q2 2011 Earnings Conference Call

July 20, 2011 16:30 ET

Executives

Mitch Haws – Investor Relations

Rich Beyer – Chairman and Chief Executive Officer

Alan Campbell – Chief Financial Officer

Analysts

Glen Yeung – Citigroup

Ross Seymore – Deutsche Bank

John Pitzer – Credit Suisse

C.J. Muse – Barclays Capital

Harlan Sur – JPMorgan

Doug Freedman – Gleacher

Ana Goshko – Bank of America/Merrill Lynch

Jeff Harlib – Barclays Capital

Operator

Welcome to Freescale’s 2011 Second Quarter Results Conference Call. At this time, all lines have been placed on listen-only mode until the question-and-answer session. Today’s call is being recorded. (Operator Instructions)

I would now turn the meeting over to Mitch Haws. Sir, you may begin.

Mitch Haws – Investor Relations

Thanks and welcome to all of you to our second quarter 2011 conference call. With me today are Rich Beyer, our Chairman and CEO and Alan Campbell, our Chief Financial Officer.

Before we begin the prepared remarks, let me remind everyone that today’s discussion contains forward-looking statements based on our current outlook and as such it does include risks and uncertainties. Please refer to our press release for more information on the specific risk factors that could cause our actual results to differ materially. Also we will reference non-GAAP financial measures and we will post the appropriate GAAP financial reconciliations to our website at freescale.com.

With that, let me now hand the call over to Rich.

Rich Beyer – Chairman and Chief Executive Officer

Good afternoon and welcome to our second quarter conference call. We are very pleased that Freescale completed initial public offering in late May and return to the public markets. Many of you on the call today played a key role in the success of the offering and we appreciate your strong support.

You will recall that the value proposition for Freescale that we described during the IPO process was to generate revenue and earnings growth above the market rate. Our Q2 results validate that value proposition.

Looking at the highlights, revenues of $1.223 billion represented an increase of 2.4% sequentially and 10% year-over-year. Adjusted gross margins increased sequentially to 45.6%, a 100 basis point increase over Q1. This performance generated adjusted net income of $70 million, a 23% increase from Q1. And adjusted earnings per share were $0.33.

Our design wins in the quarter continued at a record pace and were strong across all of our target markets and regions. Now, Alan will provide additional insights into our financial performance in Q2. I will then provide an update on some business highlights and our Q3 outlook. After which, we will be happy to entertain your questions.

Alan Campbell – Chief Financial Officer

Well, good afternoon and thank you again for joining today’s call. As Rich said, Q2 represented another quarter of solid execution and marked our eighth consecutive quarter of sales growth and our ninth consecutive quarter of gross margin expansion. As I review the financial results in more detail, please note I will be focusing on the results excluding the impact of purchase price accounting and certain other items. We believe this to be a more meaningful representation of our ongoing financial performance.

Let me now drill into the second quarter. Revenues were $1.223 billion, representing a sequential and annual increase of 2.4% and 10% respectively. This was higher than the outlook communicated at the beginning of the quarter. We do believe some of this growth resulted from our customers across all regions increasing inventory as a reaction to the earthquake in Japan.

Our Microcontroller product sales were $430 million, 1.4% above the first quarter and 11% above Q2 of last year. Automotive Microcontroller sales were down from Q1 that grew 11% compared to the same period last year. Sales of our microcontrollers into the industrial markets increased more sequentially and a year-over-year basis. Networking and Multimedia revenues were $312 million in the quarter, up 3% from both Q1 and from Q2 last year. Our Networking revenues benefited from a moderate improvement in the service provider and enterprise markets.

Revenues in our consumer-focused businesses declined slightly from Q1 as expected, but were up over Q2 last year. RF, Analog and Sensor product net sales were $315 million, a 9% above the prior quarter and 24% above Q2 of last year. In Q2, our RF business saw solid growth in the wireless market. Our Analog and Sensor businesses also experienced growth on a sequential and year-over-year basis. Analog revenues grew from Q1 and Q2 last year based on strength in both Auto and Consumer with the sensor business benefiting primarily from growth in our consumer portfolio. Our Cellular product sales were $122 million and were down on both sequential and annual basis.

Other products which consist primarily of foundry sales and IP revenue resulted in net sales of $44 million compared to $39 million in the first quarter and $31 million of last year. Finally, sales to our distribution increased 5% sequentially and were up 14% compared to Q2 of last year. Distribution represented 24% of our sales in the second quarter. Distribution inventory was at 10.9 weeks and this compares to 9.3 weeks in Q1 and 7.9 weeks at the same time last year. Our book-to-bill in the second quarter was 1 flat with the first quarter.

Now, let’s look at gross margin and operating expenses. We continue to make sequential and annual improvements in gross margins. On a sequential basis, adjusted gross margin improved by 100 basis points, the operational factory improvements and depreciation being the major contributors. On an annual basis adjusted gross margin improved by 470 basis points. Again this was driven by improved factory utilization, operational efficiencies, procurement improvements, and depreciation resulting from the reduced capital expenditures.

Our internal front end factory utilization was approximately 78% in the second quarter and this compares to 74% in the first quarter, and 73% in the same period last year. And looking at our operating expenses, our SG&A was $137 million or 11.2% of sales, inline with the first quarter on a percentage basis and consistent with our target operating model. Our R&D in the quarter was $207 million or 17% of sales, also in with the prior quarter on a target operating model. The level of investment in R&D continues to support growth initiatives targeted in our core markets and product areas.

Adjusted operating earnings again improved on both sequential and year-over-year basis. Excluding the impact of purchase price accounting and other items, second quarter operating earnings were $216 million or 17.7% of sales compared to 16.8% of sales in Q1 and 12% of sales in the same period last year. Adjusted net earnings in the quarter were $70 million, exclusive of purchase price accounting, reorganization charges, stock based compensation and other adjustments included in today’s earnings release. This compares to net earnings of $57 million in Q1 and a loss of $10 million in Q2 of last year.

Earnings per share exclusive of the above adjustments were $0.33. This compares to $0.29 in Q1 and a loss of $0.05 last year. EBITDA also improved on a sequential and year-over-year basis. In the second quarter EBITDA was $292 million or 24% of sales compared to $287 million or 24% in the first quarter and $229 million or 21% in the same quarter last year. Adjusted EBITDA was $1.3 billion on a trailing 12-month basis.

Our working capital continues to be tightly managed and represented 19.2% of sales. Day sales outstanding were 35 days in the quarter, down 1 from Q1 and 3 days from the same period last year. Payable days were 55 compared to 54 in the first quarter and 56 in the same period last year.

Inventory dollars were slightly ahead of Q1 and total inventory days were 101 as compares to 101 in the prior quarter and 87 days in the same period last year. Excluding the impact of build ahead inventory associated with our factory closures, inventory days were at 93. Cash, cash equivalents were $805 million. We contributed approximately $313 million of our cash balance that proceeds from the IPO and greenshoe to deleverage.

In addition to cash recalled, we do have undrawn revolving credit facility of $425 million. Our capital expenditures for the quarter were $37 million approximately 3% of sales. Given our consistent execution on managing cash, we continue to have solid liquidity. Our cash and cash equivalents coupled with undrawn revolver offers us the opportunity to continue to invest in the business, fund capital expenditures and continue to de-lever.

At the end of the second quarter, we also have restricted cash on our balance sheet of $887 million. This represents the green shoe of proceeds from the green shoe as well as the 2020 new 8.05 visions, which along with the existing cash was used in July to feed the 2014 maturities. That does offset in the coming debt item line in the balance sheet and just presents the timing issue between receiving proceeds and extinguishing the debt.

Now let me talk briefly about the capital structure. Total debt following the IPO and the exercise of the over-allotment option on July, refinancing is approximately $6.6 billion. We used $742 million of net IPO proceeds and existing cash to payoff entire drawn revolver to retire the PIK toggle notes and also to reduce the 2020 10.75 notes.

Net proceeds from the green shoe was approximately $95 million and that was used to retire $87 million of the 2018 10.8 secured notes. As a result of the above, the interest charges will be reduced by $15 million per quarter with the full impact expected in the third quarter.

As noted in the income statement, we incurred approximately $121 million in charges during the quarter, which was associated largely with the IPO and call premiums associated with the related debt reduction efforts completed in early June. Approximately $68 million of this charge was associated with the sponsor of termination fee.

Approximately $42 million of the charge was related to call premiums and other related costs associated with paying down the debt in the quarter. Total debt following the IPO, the green shoe and cash usage will have been reduced by over $1 billion. Net debt inclusive of the transaction is approximately $5.8 billion.

At this point, I would like to now turn the call back to Rich.

Rich Beyer – Chairman and Chief Executive Officer

Thanks, Alan. I would like to touch on some recent highlights that underscore Freescale’s momentum in the marketplace. First let me comment on our recent Freescale Technology Forum. We had more than 2500 customers in ecosystem partners registered for this year’s Freescale Technology Forum.

We offered more than 350 hours of technical training and more than a 180 demonstrations in our interactive Technology Lab. This tremendous responses and affirmation that Freescale is providing the embedded processing solutions that the market needs for numerous next-generation applications. We also announced the number of new products over the past quarter and at the technology forum.

Let’s look at these another activities by market. Let’s talk about our Automotive business. In Automotive, we expanded our industry leading Qorivva higher performance microcontroller portfolio with the new 32-bit MCU that incorporates Ethernet connectivity and video compression features that will make parking assist systems more affordable.

In collaboration with BMW, Freescale has developed a New Qorivva microcontroller that eliminates the need for dedicated signaling cables and enables video transmission over a simple two-wire Ethernet cable for 360 degree view around the vehicle. This promises to bring video assisted parking systems to the mainstream market.

As vehicles are becoming more complex with interconnected engine, safety and electrical systems, dashboard displays are becoming the drivers’ information hub for vehicle modifications and collusion warnings. Freescale introduced the industry’s first single chip solution for sophisticated automotive dashboard displays. Our New Qorivva S family integrates high-end graphics and analog functions for true single chip solution to power the next-generation of automotive instrument cluster applications.

Let’s talk about our Networking business. In our Networking business, the dramatic expansion of connected smart mobile devices has continued to see the appetite for network bandwidth to support data intensive multimedia applications. At our Technology Forum, we introduced our next generation QorIQ Advanced Multiprocessing Series of communication processors. These are built on 28-nanometer process technology. These devices will feature our new 64-bit multi threaded core based on Power Architecture technology and incorporating new accelerating engines for improved fix function processing. These high performance QorIQ products will span from 2 to 24 virtual cores providing 4x the application performance at half the power consumption over our highest performance QorIQ P4 platform.

We also announced agreements with ecosystem partners including Wind River and QNX. They will advance our software solutions and development support for our QorIQ multicore platforms. Freescale is committed to providing outstanding developer, technologies, and software that fully leverage the capabilities of our products and improve customer time to market and ease of use.

In wireless networking infrastructure, mobile data traffic is projected to double every year through 2015 and today’s base station equipment must support multiple modulation standards and increasing signal bandwidth with shrinking form factors. In Q2 we announced our new Airfast RF power transistors that will deliver the industry’s widest bandwidth products to support signals in excess of 150 megahertz instantaneous bandwidth and enable simultaneous operation over multiple communication bands. Freescale’s Airfast RF power devices are designed to provide higher device efficiency than the latest generation of LDMOS products and deliver 25% higher power density.

Let’s now look at our industrial market. Freescale achieved another significant milestone in our Kinetis 32-bit microcontroller portfolio. In an independent test conducted by the Embedded Microprocessor Benchmark Consortium, Freescale’s Kinetis microcontroller set an industry record for benchmark performance for our microcontroller based on ARM Cortex-M4 technology. Freescale is currently sampling six families in our Kinetis portfolio that feature a broad array of ultra low power microcontrollers with human machine interface, connectivity, safety and security functionality. We also announced our new Kinetis K70 microcontroller family that will feature LCD graphic capabilities and tamper detection features. These products are ideal for many at the new three phase metering and network metering applications required for the deployment of the smart grid.

Now, let’s look at our Consumer business. A new breed of mobile processors will be required to deliver the improved performance with lower power consumption for the next generation of smart mobile devices. At our Technology Forum, we demonstrated our first-rev working silicon for our i.MX 6 quad-core processor, just six months after we announced our introduction plan at the Consumer Electronics Show. The i.MX 6 represents the industry’s first SoC that combines 4 ARM CPU cores with a full 64-bit memory bus. We demonstrated the processor’s multimedia capability by showing a 3D graphics video game while simultaneously streaming full 1080p resolution video.

We also introduced our new high precision extrinsic pressure sensor. The sensor enables a new wave of advanced location based applications for tablets and smart mobile devices as well as medical and industrial devices. For example, a device using this sensor could detect the exact flow of users on within a high rise building or a shopping mall, allowing location based services to more accurately reflect the immediately surroundings.

With that let’s turn to our Q3 outlook. As we look at Q3 revenue expectations, we see several positives, but also a number of headwinds. Our Networking and Consumer businesses should continue to grow well in the quarter. Our Automotive business continues to be somewhat challenged. Overall, vehicle production which dropped in Q2 will also drop again in Q3. And more specific to Freescale, North America, Europe and Asia where we are stronger will be down in Q3. Japan production is expected to improve.

More broadly, we have seen inventory grow at selected customers and distributors largely as a reaction to the Japan earthquake situation. We could experience a modest inventory correction affecting Automotive and Industrial businesses. And our Cellular product business as expected will continue to decline. So, we now expect our Q3 revenues to be flat to down 3% from Q2 levels. However, we do expect to continue to deliver sequential improvement in gross margins and overall profitability. We expect to generate 50 to 75 basis points improvement in gross margin in Q3. The improvement in gross margin combined with interest expense reduction should enable us to improve our profitability again in the third quarter.

So, let me summarize. We have executed on a very solid Q2 with revenue, gross margin, adjusted net income, and EPS all growing sequentially and relative to 2010. We achieved record design wins again in Q2 and we continue to strengthen our leadership positions in our target markets. And finally, we expect to continue to deliver solid profit growth in the future.

With that, Alan and I would be happy to answer the questions. Operator?

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Our first question comes from Glen Yeung with Citigroup. Your line is open.

Glen Yeung – Citigroup

Thanks guys. A question on the outlook, when you think about specifically what you are seeing thus far into the quarter in terms of the way you are thinking about where revenues will go. Can you just describe to us the kind of visibility that you are getting from your customers on Q3 at this point, maybe give us a feel for what the order trends look like? And I am just trying to engage how much of this is sort of you guys being nervous about what we are seeing in macro versus what you are seeing in micro?

Rich Beyer

Yeah, Glen. So, in the Networking business as well as the Consumer business, we are seeing the natural pattern, that we would expect the bookings are fine, the backlog is fine and growing. In the Automotive and the Networking businesses, we are seeing customers re-looking at their inventory positions. This is true of distributors as well as OEM customers in the number of different markets. There was clearly reactions as a result of the earthquake in our Microcontroller business and in our Analog, Sensor business, where customers were in fact anxious to get products and they have since the latter part of June and into the first two weeks of July been re-looking at their inventory levels at where things in fact are calming down. And so we have seen a bit of inventory of steps for them to manage their inventory for the first couple of weeks. That is starting to settle down as we speak.

Alan Campbell

I think Rich meant to say that actually Auto and Industrial.

Rich Beyer

It is, I am sorry.

Alan Campbell

Yeah. So, the Networking and Consumer hanging in to the relatively strong in Automotive and Industrial.

Rich Beyer

Okay.

Glen Yeung – Citigroup

And then just as a follow-up gross margin guidance upward, what’s the expectation for utilization rates in light of the revenue guidance for Q3?

Alan Campbell

Yeah, first of all, Glen, the utilization did improve from the first quarter to second quarter. Some of that improvement was due to engineering as a result of the qualification of products that we are trying to accelerate from the Sendai closure. We are modeling in at this point flat to slightly up utilization getting to the third quarter.

Operator

One moment please. Mr. Yeung, your line is still open sir.

Glen Yeung – Citigroup

I am good. Thanks.

Alan Campbell

Next question?

Operator

Yes. Our next question comes from Ross Seymore with Deutsche Bank. Your line is open.

Ross Seymore – Deutsche Bank

Hi, guys. Also on the outlook looking at that time Automotive side of things, do you believe that the inventory is just limited to the Japanese impact or is it something where you believe that lower production plus inventory something we are going to have to digest more globally?

Rich Beyer

I think Ross the situation is almost exclusively created by the Japan situation, but it is self globally. There is no question that OEMs in Europe, North America and Asia have been impacted by their ability to get all of the components they need and on the one hand they have been ordering parts to be able to build systems and occasionally can’t get other parts to be able to complete the system. So, in our judgment all the issues round automotive are associated with the difficulties created by the earthquake in Japan, but they’re felt broadly around the world.

Ross Seymore – Deutsche Bank

And I guess it’s a follow-on on that do you believe that something that can be digested within one quarter and should we expect inventory to fall both in the channel and on your balance sheet or more one than the other?

Alan Campbell

We think it will be rectified in the third quarter. From the visibility we have it certainly looks that way and the inventory that we discussed is really the inventory in the hands of both our OEM customers and distributors. Our inventory situation seems to be in reasonable shape.

Ross Seymore – Deutsche Bank

Great, one quick housekeeping OpEx Alan I didn’t think I heard you say anything on that?

Alan Campbell

The OpEx is very consistent with target model 11% SG&A, and 17% of sales. So, in the second quarter our SG&A our $156 million and our R&D was $207 million.

Ross Seymore – Deutsche Bank

More going forward though?

Alan Campbell

More going forward though, it would be consistent again that the target model, which is 11% of sales and 17% of R&D. So, from a modeling standpoint I think using that target model is very reasonable.

Ross Seymore – Deutsche Bank

Okay. Thank you.

Operator

Thank you. Our next question comes from John Pitzer with Credit Suisse.

John Pitzer – Credit Suisse

Hi guys. Thanks for let me to ask the question. Rich on earlier comment about, your expectation of this is you resolve the inventory use issue in the September quarter. I just guess given some of the macro uncertainty, what’s the confidence level that is just a one quarter ahead and I guess helping me understand if it's just transitory, do we start to make that revenue up in the December quarter?

Rich Beyer

Yes, as we look at our customers and what they’ve done in terms of building inventory and what they’ve been doing of late in getting things corrected and we lay that up against their build plans for the remainder of the year. What we see is that there is still struggling as we speak with the ability to get every component necessary for every subsystem. But the indications are that every week that goes by that’s getting rectified. So, we do see that we are going to see seasonally down picture in the number of markets around the world including North America and Europe.

But all the indications are by Q4 the situation will be back under control and demand will pickup at disproportionately professionally high rate relative to normal production. So, we are reasonably confident that this is a short-term phenomenon that will be fixed over the next several months.

John Pitzer – Credit Suisse

I think as I apologized, the guidance on the cellular business, what you’re seeing for the September quarter and I guess given some of the tribulation the some of your big customers there did you think were kind of that appropriate levels for the cellular business?

Rich Beyer

John, we said that the cellular will continue to decline and we didn’t give specific associated with that. But we expect a little bit more decline in the third quarter than we saw in the second quarter.

John Pitzer – Credit Suisse

And then lastly guys just quickly, on the gross margin improvement in September, what are the big leverage points there? Is it better mix or is this more kind of the restructuring, kind of flowing the P&L?

Alan Campbell

It really is the element that we have discussed before John, a little bit on the factory footprint, although with the revenue guidance we have given, we think as we said (indiscernible) will be relatively flat, maybe slightly up. Operational efficiencies were certainly continue as procurement and a little bit in depreciation so it’s basically all the elements we have talked about before are contributing to the continued sequential improvement.

John Pitzer – Credit Suisse

Great, thanks guys.

Operator

Thank you. Our next question comes from C.J. Muse with Barclays Capital.

C.J. Muse – Barclays Capital

Hi, good afternoon. Thank you for taking my question. I guess first question trying to probe a little bit deeper on the gross margin side. The 100 bps improvement in Q2 clearly came in above plans. I’m curious was there predominately depreciation or whether other factors in there that was should be taken of.

Alan Campbell

Probably just less than half was depreciation and a large portion also was associated with the operational efficiency. We don’t see as much on factory footprint this quarter. So, again as we have said before C.J., about looking at all those four to five vectors to improve gross margin that will vary by quarter, but the second quarter it was predominately the depreciation and operational efficiency.

C.J. Muse – Barclays Capital

That’s helpful and then looking to, I guess Q4 is Toulouse Fab closure on track and what kind of improvements should we be thinking about I guess looking into the Q4-Q1 timeframe?

Rich Beyer

As you know the plan of record is to close that at the end of this year. So, we did not anticipate benefits in the fourth quarter. The benefits would all accrue in 2011. We are looking at the demand profile from our customers for end of life builds and so forth and so that is a subject under review as we speak and discussions with our customers to see whether or not the December date is on track or whether we need to accommodate additional bills.

C.J. Muse – Barclays Capital

That’s helpful and then last question from me on the networking side, in terms of seeing sequential strength there going into Q3. Do you think that’s in line with broader industry trends or are there design wins that gave you confidence that perhaps you’re outgrowing the market there and if so, if you could elaborate?

Rich Beyer

To be candid, we are not sure we haven’t seen the results of any other of our competitors in that space. We do think that the fact that we grew in this most recent quarter as well as see the backlog laying into grow this quarter suggest that we will continue to do quite well in this overall marketplace. Not sure whether that represents share gains versus any of our competitors yet.

C.J. Muse – Barclays Capital

Thank you.

Operator

Thank you. Our next question comes from Harlan Sur with JPMorgan.

Harlan Sur – JPMorgan

Thank you for taking my question. I apologize if I missed this, there are a lot of questions about your automotive business and you said it would be down in Q3, but is the industrial business also going to decline quarter-over-quarter. And then along the same lines as some other questions on the automotive business, what’s your confidence that this is just an inventory work down versus the slow down in sort of a broad industrial demand.

Rich Beyer

Harlan, on the industrial markets we currently envision it would be flat. It could be down if in fact we see a potential inventory correction. We have seen with the handful of customers, where they built-up inventories as a result of the earthquake. We will have to see what their fundamental demand is. So, that’s why we are indicating that, if the demand holds the macro condition hold and they do not bleed off inventory we expect our industrial business to be flat. If even macro or inventory correction takes place it is down and that’s what we built into our expectations.

Harlan Sur – JPMorgan

And if I may Rich, what is your industrial business do in Q2?

Rich Beyer

The industrial business was up in Q2.

Harlan Sur – JPMorgan

It was up in Q2. Okay, great. And then my follow-up question along those same lines as the previous caller, you previously talked about China wireless infrastructure demand coming back in driving growth in the networking business in the second half of the year. Is this part of what’s driving the incremental growth in 3Q and maybe can you just touch upon what wireline service provider fundamentals were like in Q2 and are looking like in Q3. Thank you.

Rich Beyer

Yes, Harlan, the Chinese rollout of additional wireless systems is in-force and it is helping as we speak and we will continue to help in the second half of the year. But I think as many people have said the size of that is less than was originally projected and less than last year. But it is happening and we are certainly benefiting from it. In the second quarter, we saw growth both in the wireline side of the business as well as well wireless.

Harlan Sur – JPMorgan

Okay, great. Thank you.

Operator

Thank you. Our next question comes from Doug Freedman with Gleacher. Your line is open.

Doug Freedman – Gleacher

Hi, guys. Great. Thanks for taking my question. Rich, you guys have had pretty nice introduction of new products. Can you talk a little bit about design win momentum and what you are seeing on the design win goals?

Rich Beyer

Yeah, during the road show we talked about and provided a fair amount of insight into design wins and how strong they have been over the last two years. We also indicated that in Q1 we had record design wins as a corporation. While I didn’t elaborate on it today, Q2 was even better than Q1, very comprehensive set of design wins across all of our businesses and each of our geographic regions saw increases in design wins. We have no doubt that the strategic focus that we initiated several years ago and the energizing of R&D and the new products are absolutely working. The Qorivva family of products, the Kinetis family of products, the ColdFire plus family of products, the Extrinsic, the RF products that we’ve announced are all very, very powerful and are getting very, very significant traction which gives us a great deal of confidence that things are going to continue on a very, very healthy pace for us.

Doug Freedman – Gleacher

Can I get you to focus in a little bit on the i.MX platform, product that was demoed at the Tech Forum was quite impressive. Is that gaining – can you give us an early indication whether you are getting, where the interest level on that product is standing? And then I've got just two housekeeping items.

Rich Beyer

I think it is very fair to say that demonstrating that quad-core ARM processor was very, very effective, has been very, very well recognized by a broad set of people in the industry. So, the level of intensity and interest in that product is very significant. It’s too early to be claiming design wins on that. But I will say that the i.MX family of products in Q2 had a very, very healthy performance in terms of design wins for e-readers, white box tablet manufacturers etcetera.

Doug Freedman – Gleacher

Great, and if I could, Alan, a couple of housekeeping items. Share count for the forward quarter, I know the share count is moving around with the IPO. Do you have an estimate of where we should be at, on that?

Alan Campbell

Yeah, we’ve used 255 at this point, Doug.

Doug Freedman – Gleacher

Okay, great. And Rich you made a comment that we should cellular to be down sort of a similar amount from what we just saw April to July. Is that in dollars or in percentage change?

Rich Beyer

It will be down. What I hope I said, it will be down a little bit more in dollar terms than the decline from Q1 to Q2. Remember we’ve indicated that this thing should be headed down towards $100 million or so per quarter. It’s going to head down in that direction for this quarter.

Doug Freedman – Gleacher

Great. Thanks for the details.

Operator

Thank you. Our next question comes from Ana Goshko with Bank of America, Merrill Lynch.

Ana Goshko – Bank of America/Merrill Lynch

Hi, thanks very much for taking the question. I have a couple on the free cash flow outlook. So, Alan I’m wondering if you believe you’re poised to generate free cash flow in the second half of this year. And specifically I know the company has taken some significant charges related to the closure of Sendai, I’m wondering if those cash payments are reflected in this quarter or there is some more cash payments to be made related to that in the second half. And related to that, are there any material insurance proceeds that you expect to receive from the damage there?

Alan Campbell

Yeah, let me take each of those, Ana. From an operating of free cash flow, yes, we do believe we’ll continue to generate free cash flow. If you look at our second quarter performance, it was somewhat mitigated by a couple of elements. We had a sponsor fee of 60 million that we had to payout and also the timing of the interest payment. There was over 200 million of interest payment. So, without those items, the cash flow would have been a little bit positive.

In terms of the Sendai situation, the actual severance payout today has somewhat limited. We believe that will actually be incurred in the start of the fourth quarter. So, from a cash flow planning standpoint, we should schedule something and there for the beginning of the fourth quarter. In terms of insurance, we are continuing to work with the insurance. There is tremendous amount of work being done, continues to be done and it’s probably premature to be talking about any proceeds as a result, but you can be rest assured that we are continuing to push on that.

Ana Goshko – Bank of America/Merrill Lynch

Okay. And then I know the company has talked a lot about its desire to continue to reduce debt. So, as you do generate free cash flow, how should we think about that being applied to debt reduction? Is there a minimum amount of cash that you want to keep on the balance sheet and then above and beyond that will you continue to apply the free cash flow to reduce the high yield debt?

Alan Campbell

Yeah. The minimum amount of cash that we have communicated at this point is $750 million. Pre-IPO we were holding over $1 billion and we have taken it down. The second quarter was actually ended up slightly more favorable at $805 million. The $750 million is the kind of threshold at this point and anything beyond that we are looking to continuing to buyback.

Ana Goshko – Bank of America/Merrill Lynch

Okay, great. Thanks very much.

Operator

Thank you. Our next question comes from Jeff Harlib with Barclays Capital.

Jeff Harlib – Barclays Capital

Hi. Just on the qualification of your fabs and outside foundries post Sendai closure, can you just update us on how that’s going and you talked about some acceleration of cost savings as well as CapEx into 2011. Can you just update us on that?

Rich Beyer

Sure. Jeff, so we were in the process of qualifying products and processes from both Toulouse and Sendai and that has been an ongoing process. With the damage to the Sendai facility, we had to accelerate the qualification of processes some had started, but were at early stages, some were well along, but needed to be accelerated. So, we have been dedicated quite a bit of energy, engineering resource, and working with customers to qualify all of the products from Sendai that are intended to be qualified.

We are continuing to do the product from Toulouse. I would say that Toulouse is on the same pace that we expected to be on. The Sendai obviously is at a much heightened pace and Alan alluded to it. Obviously, we are getting some utilization benefit from producing wafers in our existing fabs that used to be produced. In Sendai, we are also seeing an acceleration in the use of the fabs to qualify more products. But I would say these efforts are under way. And from a cost standpoint, Alan, you want to address that?

Alan Campbell

Yeah. We have previously communicated, as you know, Jeff that the intent was to accelerate some capital expenditures to facilitate the qualification of those products and that is still the case. At the same time, however, we continue to tightly manage our overall CapEx. In the second quarter, we spent $7 million or 3% of sales. And we expect the CapEx to slightly increase from that level until the third quarter, but we continue to drive on the overall capital expenditure and there will be some incremental required as a result of the qualification.

Jeff Harlib – Barclays Capital

Okay. So you are in the 3%, 3.5% of sales range this year, is that reasonable CapEx?

Alan Campbell

Yes, that’s reasonable, yeah.

Jeff Harlib – Barclays Capital

Okay. And on the $120 million of full run-rate savings post Sendai and Toulouse, do you see that when should we start to see the benefits there and when do you expect to achieve the full run-rate?

Alan Campbell

Look that gets into two buckets, first of all, is Sendai and then secondly I will talk about the Toulouse situation. The highest level, first of all, the savings will be a result of our ability to qualify products in our existing factories. As a result what we do there is we obviously run on an existing footprint utilizing existing fixed cost and that’s where the savings get materialized. As we have said before, the savings don’t immediately impact because of an inventory situation, i.e., we are building inventory. We have got to deplete that inventory off. On seeing all that, on Sendai, we really expect to see some of the savings start to kick-in in the fourth quarter. And I think on the Toulouse with the inventory situation and the customer reviews that we are doing, we still believe it’s for modeling purposes Q2/Q3 timeframe before we see the savings.

Jeff Harlib – Barclays Capital

Okay, that’s helpful. And just last question on D&A, it was like it came down by $10 million, $11 million in the quarter, what’s the rate that, that should come down over the next few quarters just for modeling?

Alan Campbell

Yeah. Actually, it slows down now into the second half. I think it’s in low single-digits for Q3 and similar again in Q4. So, it’s in the $4 million, $5 million in Q3 and dropping a little bit more in Q4.

Jeff Harlib – Barclays Capital

Great, thanks.

Rich Beyer – Chairman and Chief Executive Officer

Okay. Operator, I think we will close it at this point. Let me just say we are very pleased that it was a very solid Q2 on virtually all financial dimensions as well as continued growing of the design win momentum that we have experienced now for couple of years. We obviously are seeing the headwinds that we outlined before, but we are confident that those headwinds are very short-term in nature and that the overall strategy and financial vector of the company is on track. So, thanks very much for everybody’s interest and we will see in 90 days.

Operator

This concludes today’s conference. You may disconnect at this time. Thank you for your participation.

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