Freescale Semiconductor CEO Discusses Q4 2011 Results - Earnings Call Transcript

Freescale Semiconductor Holdings (FSL) Q4 2011 Earnings Conference Call January 26, 2012 5:00 PM ET

Executives

Mitch Haws – Investor Relations
Rich Beyer – Chairman and Chief Executive Officer
Alan Campbell – Chief Financial Officer

Analysts

Ross Seymore – Deutsche Bank
Stacy Rasgon – Sanford Bernstein
Jason [ph] – Oppenheimer
C.J. Muse – Barclays Capital
John Pitzer – Credit Suisse
Glen Yeung – Citi
Doug Freedman – RBC Capital Markets
Frank Jarman – Goldman Sachs
Jeff Harlib – Barclays Capital
Harlan Sur – JP Morgan
Ann Lee [ph] – BMO Capital Markets

Operator

Welcome to Freescale’s Q4 and Full Year 2011 Results Conference Call. (Operator instructions) I will now turn the meeting over to Mr. Mitch Haws. Sir, you may begin.

Mitch Haws

Thanks Kim, and welcome to all of you to our fourth 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 does include risks and uncertainties.

Please refer to our press release, Form 10-K, or other filings with the SEC 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 reconciliation to our website at freescale.com.

With that, let me turn the call over to Rich.

Rich Beyer

Good afternoon and welcome to our fourth quarter conference call. Q4 marked another challenging quarter for Freescale and the rest of the semiconductor industry. Global macroeconomic conditions and demand continued to weaken in many markets, which negatively impacted sales and profitability.

Despite the pressure on the top line for Freescale, we executed well on gross margin, operating expense and earnings per share. Looking at some of the highlights, revenues of $1.013 billion represented a decrease of 11% sequentially. Adjusted gross margins were 43.9%, 220 basis point below Q3, but above the prior year and in line with our outlook.

This performance generated adjusted net earnings of $18 million, and adjusted earnings per share were $0.07.

Now Alan will provide additional insights into our financial performance in the quarter. I will then provide an update on some of our business highlights and our Q1 outlook, after which we will be happy to answer your questions.

Alan Campbell

Well, good afternoon again. Thank you for joining today’s call. As Rich said, Q4 was challenging, but we continued executing well on gross margins, operating expenditures and cash. As I review the results in more detail, please note that I will be focusing these results, excluding the impact of purchase price accounting and certain other items. We believe this is a more meaningful representation of our ongoing financial performance.

In addition, recall that we recently realigned our operations to create two new strategic product groups, the networking and multimedia solutions group, NMSG; and the automotive industrial multimarket solutions group, AISG. The newly created NMSG, which includes networking, multimedia, radio frequency products will be led by senior vice president and general manager, Tom Deitrich. The AISG product group, which includes microcontroller, analog, and sensors products will be led by our senior vice president and general manager, Reza Kazerounian.

We expect to report sales consistent with the two new product groups in the first quarter of 2012. Now looking at Q4 and 2011 in more detail, Q4 revenues were $1.013 billion, representing a sequential decrease of 11%. Sales declined by 14%, or $169 million compared to Q4 of last year.

For the full calendar year of 2011, net sales grew approximately 3% to $4.57 billion, and this compares to $4.46 million in 2010. In Q4, microcontroller product sales were $355 million, 10% below the third quarter and 14% below Q4 of last year. We saw automotive sales slightly decline in Q4.

Sales of our MCUs into the industrial markets were significantly down on both a sequential and year-over-year basis due to end demand and some correction in inventory. For calendar year, microcontroller sales grew 1% to 1.6 billion, reflecting strong sales of our auto and industrial MCUs in the first-half of 2011.

Networking and multimedia revenues were $279 million in the quarter, down 4% from Q3 and down 17% from Q4 of last year. Our networking revenues were negatively impacted by lower demand and pockets of elevated inventory mainly in the wireless infrastructure market. For calendar year 2011, our networking and multimedia sales declined 4% due primarily to lower capital spending trends in wireless infrastructure in the second half of the year.

RF, analog, and sensor product net sales were $292 million, 5% below Q3 and 2% ahead of last year. Sequentially, our RF business declined from Q3, given the slowdown in wireless CapEx spending in the second half of 2011. RF sales in Q4 2011 were essentially in-line with the prior year quarter.

Our sensor business is declining slightly from Q3, and improved on a year-over-year basis, benefiting from our growing presence in consumer devices. For calendar 2011, RF, analog and sensor sales grew 14%, benefiting from strong RF sales and higher sales of our sensor, and analog product to the consumer market. We also saw growth on a year-over-year basis in sales of analog and sensors into the automotive market.

Cellular product sales were $41 million, down 58% compared to Q3. This decline was consistent with our expectations. For calendar year 2011, our cellular product sales were $398 million, compared to 455 million in 2010. Finally other products, which consist primarily of foundry sales and IP revenue, resulted in quarterly net sales of $46 million. This compares to $52 million in the third quarter and $33 million in the same period last year. And for the full calendar year, other net sales grew 51% to $181 million, based primarily on higher IP revenue.

Finally, sales to distribution decreased 20% sequentially and compared to Q4 of last year, as distributors reduced their inventories. Our book-to-bill ratio in the fourth quarter was 0.92, and modestly above that of the third quarter. We have seen our book-to-bill improve so far in January, and is now trending about 1.

Looking at gross margins and operating expenses, adjusted gross margins were 43.9 compared to 46.1 in the third quarter. Gross margins were negatively impacted on a sequential basis by lower sales volumes and product mix, but we managed to substantially offset the impact through operational efficiencies and procurement savings.

Compared to Q4 last year adjusted gross margin grew 100 basis points due to the operating efficiencies and lower depreciation. And for the full calendar year, adjusted gross margins were 45.1, and this compares to 41.4 in the prior year, an improvement of 370 basis points.

Our internal front-end factory utilization was approximately 80% in Q4. This compares to 83% in Q3 and 75% in Q4 last year. The sequential reduction in utilization resulted from our plan to minimize inventory in the quarter.

Now looking at operating expenses, we continue to look very well in managing our OpEx given the challenging macro environment. SG&A was $113 million, or 11.1% of sales, in line with the third quarter on a percentage basis and consistent with our target operating model. Total SG&A dollars declined $16 million sequentially as we managed discretionary spend and incentives. SG&A dollars were down 18 from Q4 last year.

R&D in the quarter was $188 million or 18.6% of sales, slightly higher than the target model despite the decline in sales. Total R&D spend declined 12 million from Q3 due to lower compensation incentives and other discretionary expenses. R&D dollars declined $12 million from Q4 2010. Core investments in new products and technologies were not impacted. The level of investment in R&D continues to support the growth initiatives we have targeted in the core markets and product areas.

Adjusted operating earnings excluding the impact of purchase price accounting and other items were $144 million, or 14.2% of sales. This compares to $200 million in Q3, and 177 million in the fourth quarter of last year. For the full calendar year 2011, adjusted earnings were $761 million. This is 195 million improvement or 57% ahead of the same period last year.

Our adjusted net earnings in the quarter were $18 million, exclusive of purchase price accounting, reorg charges, and stock based compensation, and other adjustments included in today’s earnings release. This compares to net earnings of $72 million in Q3 and $29 million in Q4 of last year. For calendar year 2011 adjusted net earnings of 217 million, were 237 million ahead of the same period last year.

Our earnings per share, exclusive of the adjustments mentioned earlier, were $0.07, compared to $0.29 in Q3 and $0.15 in Q4 of last year. For calendar year 2011, adjusted earnings per share were $0.96. This compares to a loss of $0.10 in 2010.

Our EBITDA in Q4 was $216 million, or 21% of sales, compared to $271 million, or 24% in the third quarter and $280 million in the fourth quarter of last year. For calendar 2011 EBITDA was $1.06 billion or 23% of sales, and this compares to 957 million or 21% of sales in 2010. Adjusted EBITDA was $1.24 billion on a trailing 12-month basis.

We made progress in Q4 on working capital, which was 20% of our annual sales, and represented a modest usage of cash in the quarter. Our AR days sales outstanding were 41 in the quarter compared to 40 in Q3 and 35 in the same quarter last year. Payable days were at 55 compared to 59 in the third quarter and 57 days in Q4 of last year. Inventory dollars were essentially in-line with Q3 and total inventory days were at 127 compared to 117 in Q3 and 97 days in Q4 of last year.

Looking at distribution inventory, it was down 7%, or 28 million compared to Q3. Weaker sales inventory very slightly to 11.1.

Our cash and cash equivalents were $772 million. In addition to our cash, recall we also have access to a $400 million revolving credit facility. Our capital expenditures for the quarter were $30 million, or approximately 3% of sales, and for the full year capital expenditures were $135 million, again 3% of sales. During Q4 we received additional cash payments of $69 million related to an insurance claim we filed following the earthquake in Japan, and the impact on our Sendai facility.

In total we have received approximately $95 million in total proceeds. Given our consistent execution in managing cash, we continue to have solid liquidity. Our cash and cash equivalents, coupled with our undrawn revolver, affords us the opportunity to continue to invest in the business, fund capital expenditures, and continue to delever. Our net debt is approximately $5.8 million.

Finally, I want to provide an update on the progress we’ve made to date on the closure of our two remaining 150 mm fabrication facilities in Sendai, Japan and Toulouse, France. Recall that we plan to generate $120 million in annualized savings when we complete the closure of these facilities and to our 200 mm factories. The process of completing the transition from the Sendai facility is on track, with the accelerated schedule we started in March following the earthquake.

The Sendai facility was not reopened for production after the tragedy in March of 2011. At this time, many product qualifications and transitions have already been completed. We expect to complete the remaining transitions in the coming few months. Given the early closure of the Sendai factory caused by the earthquake, we continue to see some accelerated benefits in the fourth quarter.

With respect to the facility in Toulouse, France, we have been working with our customers to transition production to our 200 mm facility in the U.S. Recall that last quarter we announced plans to complete the closure of the Toulouse facility during the second quarter of 2012.

At this point, I’d like to turn over the call back to Rich.

Rich Beyer

I’d like to touch on some recent highlights that underscore Freescale’s momentum in the marketplace. 2011 was a very good year for Freescale product innovation, and we closed out the year with some impressive product launches.

Let me start first with our automotive business. The demand for high-performance smart connectivity is revolutionizing the in car experience. At the recent consumer electronics show in Las Vegas, General Motors announced that they would continue their 15 year track record of using Freescale’s solutions for their OnStar platform.

GM selected our i.MX 6 solo apps processor as the primary processing engine for their next generation OnStar Telematic system. As the volume of data flowing into and out of the vehicle continues to increase, protecting the security of this data is vital to both automakers and their customers. GM cited the advanced security capability of the i.MX 6 solo as a key element of their decision.

i.MX Technology currently powers the driver infotainment and telematics systems deployed by more than 10 automotive OEMs. Vehicle infotainment systems are beginning to incorporate driver assistance applications that make the driver aware of the vehicle’s surroundings. Freescale, Broadcom, and OmniVision jointly developed the world’s first Ethernet based 360 degree surround view parking assisting system. Freescale’s Qorivva 32 bit microcontrollers built on power architecture technology manage video streaming and camera control, and it uses low latency video compression together with intelligent bandwidth management for maximum quality.

The cost advantages of the solution dramatically expands the opportunity for OEMs to deploy 360 degree parking assistance camera systems across numerous vehicle platforms. To meet consumer expectations and government regulations for improved fuel economy and lower emissions, Freescale announced the industry’s most powerful microcontroller for automotive power train system. Our multicore Qorivva microcontroller provides four times the performance of the previous single core microcontroller, and enables global automotive customers to incorporate state-of-the-art technology like direct injection, turbo charging and full drive by wire systems into a single controller.

In addition to making the vehicle greener, Freescale is committed to improving the safety and security of the vehicle. Freescale introduced the new Xtrinsic family of accelerometer sensors that employs intelligent sensing technology for advanced air bag systems that help save lives, and protect against injuries caused by vehicle collision. This new Xtrinsic sensor family supplies high sensor resolution without requiring programming by the automotive manufacturers. This results in greater design efficiency and lower manufacturing costs.

Early in 2011, we introduced our new S12 MagniV microcontroller portfolio that offers both single and dual dye solutions integrated with high precision analog and scalable memory options. Our efforts were recognized this December at the 2011 embedded developer forum, where we received the best MCU award from Electronic Engineering and Product World.

These numerous initiatives and results affirm our continued success across the high growth segments of the automotive industry and position us for future revenue and profit growth.

Let’s look at our networking business. In networking, we collaborated with Emerson Network Power and Kontron to expand the I/O connectivity options for the computer on module for specification that addresses the requirements for higher performance and higher bandwidth. This collaboration expands the opportunities for our QorIQ AMP series of multicore processors in medical, security and industrial automotive applications.

We announced our QorIQ AMP series in June that our Freescale technology forum, and we have already secured our first major design win for the T4240, with a first multicore processor manufactured at the 28 nm processing node. While some of our macros sell wireless infrastructure customers, have slowed capital expenditures in response to global macro economic conditions, we are seeing increased activity around small sale solutions based on our QorIQ converged solution.

We introduced a femtocell reference design board for our PSC 9131, a highly integrated single core power architecture processor and single core DSP that handles all the digital base band processing required for femtocell standards.

In the industrial market, we introduced a new product platform for real-time control and graphics rich applications. This multiprocessing architectural platform incorporates an ARM Cortex M4 high-performance microcontroller, and a Cortex M5 energy-efficient applications processor. Industry applications like factory automation, medical devices and appliances are incorporating more connectivity and sophisticated user interfaces.

By combining the apps processor and real-time controller into one device, we’re helping our customers reduce complexity and costs. We also raised the bar on microcontroller performance by introducing the industry’s fastest microcontroller built on the ARM Cortex M4. In the medical segment, we introduced a comprehensive reference platform to help accelerate the development of medical devices with seamless connectivity and data aggregation capabilities.

Our Home Health Hub reference platform is based upon our i.MX 28 apps processor and ZigBee transceivers. It enables secure wireless and wired connectivity to remote healthcare devices such as blood pressure monitors, weight scales and blood glucometers. We believe our product portfolio and applications expertise across these industrial segments should drive sustained revenue and profitable growth in the future for Freescale.

In the consumer market, at CES we announced the expansion of our flagship apps processor family, the i.MX 6 series. We introduced our new i.MX 6 solo light processor, which is designed for next-generation e-readers. It integrates a 1 gigahertz ARM Cortex A9 core with a 2-D graphics processor, and display controllers for LCD panels. Freescale also announced the industry’s the first solution that combines gesture recognition on resistive screen technology and capacitive touch sensing in a single integrated circuit.

Our new Xtrinsic touch sensing platform offers a quick and inexpensive solution for advanced user interfaces for markets that haven’t previously incorporated touch sensing technologies. Resistive touch screens are ideal in applications where users must wear gloves like medical, security and harsh environments. Freescale is a proven leader in sensing solutions with a heritage of more than 30 years of sensor innovation.

That innovation was recognized when our Xtrinsic smart low-power accelerometer and our Xtrinsic magnetometer for location based services were recognized by Electronic Engineering and Product World with the 2011 best sensor solutions award.

Now let me take a few minutes to discuss our Q1 outlook. We expect Q1 revenues to be down in the range of $930 million to $990 million. On a sequential basis, we expect automotive revenues to be flat to slightly up, our networking revenues to be modestly down as inventory levels at our customers continue to be worked down, consumer revenues to decline due to normal seasonality, and our industrial revenues to be up modestly. We expect gross margins to decline in the quarter approximately 100 basis points to 150 basis points. We do however expect to resume revenue growth in Q2.

So in summary, despite a difficult macroeconomic environment, the company continued to generate solid gross margins. The flexibility of our asset-light model, our efficient cost structure, and our diversified revenue base are helping us to mitigate the impact of the challenging environment. We continue to generate solid design wins that position us well for future revenue and profit growth.

And with that operator, Alan and I are happy to address any questions.

Question-and-Answer Session

Operator

(Operator instructions) Our first question comes from Ross Seymore with Deutsche Bank. Your line is open.

Ross Seymore – Deutsche Bank

Hi guys. Just a question on the forward guidance, specifically on the networking side of things, can you give us a little more color on where the excess inventory is, wireless, wire line et cetera and how you see that trending from the first quarter onwards?

Rich Beyer

Okay, Ross. We see that wireless is the weakest of the segments. Our enterprise business appears to be showing signs of improvement, but the wireless side particularly, wireless obviously in the service provider side is an area where the demand has been lower, we are told by our customers, and they have inventory.

We do believe from the demand profile that we are seeing that things are improving, the backlog is improving, and we believe that we will return to growth in that segment in Q2.

Ross Seymore – Deutsche Bank

I guess one follow up then, on the gross margin side of things, can you just remind us what the puts and takes were that led to the 2 point drop in the fourth quarter, and then the 1 to 1.5 point drop give us the same metrics for the first quarter?

Alan Campbell

Okay, Ross. We have again laid out previously the building blocks of the gross margin. One is utilization, one is operational efficiency, one is procurement, and one is depreciation. What we did see in Q4, we managed our production run rate down significantly to balance supply with demand. And that created most of the reduction in gross margin. We were able to offset with the operational efficiency on procurement, depreciation didn’t fall off as much in the fourth quarter.

(inaudible) in general, but not to the fourth quarter and going forward. We are executing well on each of the elements that we have talked to, despite the gross sell out just under 44% gross margin is very positive in this type of environment. As we look into Q1, really the factory utilization is crossing the challenge also, and it really isn’t in line with the reduction in revenues that we have just communicated. So the decline in summary of gross margin really is attributable to the utilization. And again we do feel comfortable that we can continue to improve once the revenues come back and utilization starts to improve.

Ross Seymore – Deutsche Bank

Okay. Thank you.

Operator

And your next question comes from Stacy Rasgon with Sanford Bernstein.

Stacy Rasgon - Sanford Bernstein

Hi guys. Thanks for taking my question. Can you give us an idea of what the utilization expectations are in Q1, and maybe how does that – can you give us some maybe in terms of I guess gross margin compression with given amount of utilization reduction, and what does that also mean in terms of your internal inventories given that they are at relatively high levels, are you taking those inventories down next quarter?

Rich Beyer

So, let me take the questions. I will talk a little bit about utilization, first of all stating that in the fourth quarter, our utilization in the fourth quarter in the front end factories was 80% and that was down from 83% sequentially. We expect that to be flat to slightly down, again through the first quarter. As we look at our back end of assembly and test operations, with core utilization because of the number of diversified product portfolios we have, and the number of pieces of equipment. But we anticipate that to be down again in Q1, and it really has an element that is causing the reduction in gross margin.

When we have talked in the past that we expect our margin compression really associated with the reduction and utilization. So, for every 100 basis points on the front end, we saw a 25% to 30% fall through. So, every quarter adjusted by 300 basis points, we would expect 30% by 100 basis points impact to gross margin.

In terms of the inventory, we did hold inventories flat. The days of inventory did increase as a function as a result of obviously reduced revenues in the fourth quarter. That was very consistent with our plan. As we have said before, we do have end of life inventory associated with the closure of the two facilities, and that probably represents 11 to 12 days. We are comfortable where we are with inventory. As we enter into the first quarter we expect to hold inventories relatively flat in anticipation to be ready for the bounce back in the demand going into the second quarter.

Stacy Rasgon - Sanford Bernstein

Got it, and as my follow up, can you give us some ideas of what the puts and takes on gross margin might be through the rest of the year. How is your outlook for hitting your target of 50% gross margins by the end of the year you are looking?

Alan Campbell

What we have communicated again in the past is that we would expect 50 to 75 basis point improvement in gross margin each quarter. If you look at our performance on that relative to the last 9 quarter, I think it is fair to say we have tended to exceed that plan. So as we look at our gross margin improvement, we still get about 50 to 75 basis points adding on the higher side.

I think a lot will depend on the revenue and the utilization of our facilities. It is important that as we look out the building blocks, we really are executing on these building blocks of operational efficiencies, procurement et cetera, as well as depreciation will roll off. So really say that the margin expansion will be a function in large part to the utilization and revenue opportunities going forward.

Stacy Rasgon - Sanford Bernstein

Thank you.

Operator

And your next question comes from Rick Schafer with Oppenheimer.

Jason - Oppenheimer

Hi guys. This is Jason [ph] calling in for Rick. Thanks for taking the question. I guess first if you could touch on channel inventory, it looks like your shipments into the channel were down 20% quarter-on-quarter, can you just maybe talk about where that fits right now, and what is the impact to your guidance in terms of shipment into the channel for the first quarter? Thanks.

Rich Beyer

Yes, Jason, we did reduce shipments into the channel, and so they reduced their shipments. So the inventory, Freescale inventory with distributors went down in the quarter. We’re seeing signs of improvement in our business through distribution and anticipate we’re going to start to see growth in that business beginning in Q1. We indicated that our industrial business we thought would be up in Q1, and we certainly expect to continue in Q2 and beyond. That business is largely through distribution, and we’re getting signals that it is starting to firm up.

Jason - Oppenheimer

Okay, and then just looking at auto, if we could maybe split that into two buckets, Japan and a non-Japan, first of all how is your Japan auto business tracking, and then what does the design win activity look outside of Japan, and kind of what is the share gain scenario taking place here over the next couple of quarters. Thanks.

Rich Beyer

Yes, the automotive business grew nicely for us last year. The first half of the year was stronger than the second half of the year. It is pretty clear to us and others because of the situation in Sendai and across Japan that automotive customers in fact acquired inventories to support demand because of concerns about the availability of products. And while automotive continued to grow in the second half of the year, it was for us muted by virtue of the fact that they had acquired inventories in the first half of the year.

Our business in Japan is healthy. As we have said in the past the percentage of our business in Japan is lower than it is in other parts of the world, North America, Europe, and other parts of Asia. But it is growing now, the design win momentum has been very positive. Japanese customers are becoming more open to engaging with Freescale for design. So we see that on a positive note and for the year, the design wins in automotive very broadly across all of the regions were quite strong.

So we remain confident that the expansion of our automotive business is going to continue on a nice, healthy trajectory. Of course the design wins of today don’t really have an impact on revenue for a number of years into the future, but we have been gaining share from design win perspective it appears to us now for several years. So, we are confident that the automotive business is headed in the right direction.

Jason - Oppenheimer

Okay. That is it from me. Thanks guys.

Operator

And your next question comes from C.J. Muse of Barclays Capital.

C.J. Muse - Barclays Capital

Good afternoon. Thank you for taking my question. I guess first question a follow up on gross margin, in the prior quarter you talked about building your dye bank, I’m curious whether you did the same here, and thinking a little bit ahead if demand snaps back, what impact will that have on gross margin snapping back. Will that cause a delay or how should we think about that?

Rich Beyer

Let me comment on it C.J. absolutely we continue the strategy of building dye bank and reducing finished goods inventory, and we believe as a result of that that we are well positioned to respond to an uptick, which as I indicated we believe will begin in Q2. So when the uptick comes, we believe we will be able to supply demand will obviously then take more advantage of our back end operations, which will obviously contribute to gross margin expansion.

It will obviously mean less of a ramp immediately in front end capacity, but we will be back filling that dye bank inventories. So I don’t think it will have any significant slowing of the gross margins expansions that we think we will get when the demand starts to return.

C.J. Muse - Barclays Capital

It is helpful. Sorry.

Alan Campbell

Nothing to add to that. I think it has been a conscious management decision to do what we’re doing. We are building dye inventory and reducing finished goods. We know that when the market turns there tends to be a reaction of lead times extending et cetera, and we believe the inventory position we have taken, we will be in a better position to respond to that, which also will then help our gross margins will see the fall through.

C.J. Muse - Barclays Capital

Great. And as my follow up, you did a great job managing OpEx. I am assuming part of that are reversals, so curious how we should think about OpEx in the first quarter?

Alan Campbell

Yes, the OpEx. We in the panel, the breaks, in Q3 as we said before, in Q3 we did disclose a reduction in operating. These programs that we put in place are very focused on a lot of discretionary spend, but were further reduced by 20 million in Q4. The programs that we have in place we would expect to continue into Q1, but not to the same extent. So we do expect our OpEx to continue to decline, but that we will be seeing only a slight decline into Q1, but we are comfortable and confident with respect to these programs that we put in place.

C.J. Muse - Barclays Capital

Excellent. Thank you.

Operator

And your next question comes from John Pitzer with Credit Suisse.

John Pitzer – Credit Suisse

Yes, guys. Thanks. Alan, just a follow on to C.J.’s question, will OpEx be down less than revenue sequentially in the March quarter, do you think you can kind of manage OpEx to be down in line with the revenue?

Alan Campbell

I don’t want to say specifically John what the number will be because we’re still working through the programs. I think it will be in the single digit range in terms of absolute millions of dollars, it will be in the 0 to 10 kind of range. So, you know, we have put a lot of different programs in place. We did execute well in Q4, and with the programs put in place, our expectation is that will continue into Q1.

John Pitzer – Credit Suisse

And then Rich on the revenue side, a couple of questions, one, you talked about consumer being down along seasonal lines in the March quarter, is that just referring to the multimedia business, or is that also inclusive of the cellular business, and given some of the dynamics that have been going on in the cellular business how do we think about that business from the December levels going forward, and then I have a follow-up on the demand side.

Rich Beyer

John, it doesn’t include the cellular business. It refers both to our applications processor business, and sensors and some of the analog stuff and a modest amount that goes into the consumer space. The cellular business is expected to be in the range that we achieved in Q4. We don’t expect that to trail off. As we have said before, we think we are now down at a level that is going to be relatively flat for a bit.

John Pitzer – Credit Suisse

Perfect, and then just lastly Rich, relative to your comments that you think Q1 is the bottom and you start to resume sequential growth in Q2, can you just give us a little bit more detail as to why you have confidence, is the expectation that book to bill will be greater than one as bookings grow sequentially in March. Is the sequential growth in June incumbent upon Wireless CapEx coming back or any detail there will be helpful?

Rich Beyer

The reason we’re gaining confidence that Q2 will be the resumption of growth is that in the October timeframe, we still were experiencing, we think it is consistent with what was transpiring with a lot of our compatriots that there was continued deterioration in backlog. That flattened in November for us and began to grow at the beginning of December. That has continued for us in the month of January. So we now have seen improvement in demand now for seven or eight weeks.

We have also spoken to a pretty broad range of customers, including our distributors, who indicate that they also feel that their demand while not storming is improving, and so we are at a position today where the view into Q2 is very solid. It is not predicate – the growth in Q2 is not predicated on any major change in any kind of programs like the roll-out of more of the base stations in China. We expect some improvement in things like that, but it is not predicated on any single thing happening that has high risk that might be delayed.

John Pitzer – Credit Suisse

Perfect. Thanks Rich. It is helpful.

Operator

And your next question comes from Glen Yeung with Citi.

Glen Yeung – Citi

Thanks. Hi Rich, can I just follow up on that last comment that you made, can you maybe just address the breath of the kind of order recovery that you are seeing either across the most of or all of your markets, that is kind of part A. Part B of the same question is, is your sense that this is inventory replenishment on the part of your customers, I know you mentioned demand just there, but is there an inventory replenishment component to it, and then Part C, for the same question is, is that driving above seasonal second-quarter in your minds?

Rich Beyer

So, Glen, the backlog, the demand and backlog improvement is across networking, automotive and industrial. Not consumer as I indicated, because it is seasonally down, and our cellular business is relatively flat. So it is across the three major cores of the company. And the indications are that some of it has to do with improving inventories of our customers, but some of it has to do with improving shipments in some areas of the customers.

Does it mean that we will be above seasonal growth in Q2? Glen, it is a little bit early to project that, but it does clearly feel to us like this is the beginning of a return to growth, and it is certainly in the last month of December, and the first three weeks of January suggest that it is a different profile that we’re looking at compared to 90 days ago, and certainly 180 days ago.

Glen Yeung – Citi

As a follow up, I wanted to ask about two specific end markets. First one actually being consumer, which you mentioned, I just want to get a sense is the consumer weakness purely seasonal, or are there other factors that play, any program losses or any customers that you feel are doing especially poor with you in the first quarter. And actually just, sorry I forget, the other question is on auto, where sign [ph] has generally been good, but we are starting to see some mixed data points in the auto market. And is that something that you can work your way through because there seems to be some content, or should we be getting a little nervous about the durability of auto orders?

Rich Beyer

The consumer business for us is purely seasonal. There is nothing going on in terms of programs that are disappearing that are having an impact on the consumer business. We just see it as the natural roll off after the Christmas season. So nothing untoward going on there other than seasonality.

In the automotive business, we are working with our customers and getting insight into the large customers. We are not expecting anything dramatic to change. We do however see examples of where things are improving, the customers’ inventory builds of Q2 and Q3 are coming back in line. We haven’t seen anything Glen that suggest as it relates to the very broad set of customers we have around the world that anything in particular is going on to cause us concern in the automotive business. We have indicated that we only expected to be up slightly in the quarter.

Glen Yeung – Citi

Great. Thank you.

Operator

And your next question comes from Doug Freedman with RBC Capital Markets.

Doug Freedman - RBC Capital Markets

Great. Thanks guys for taking my question, and Rich, you have done a lot of things through this cycle that we are hopefully exiting here, any chance that you can give us any sort of goalpost now on when you think you can get back to your target, and has your target changed in any way, is there a new revenue level at which you think you can achieve those goals?

Rich Beyer

I think no, the answer is there is no change in the target. There is no change in the revenue expectations. Clearly we are a smaller company than we were six months ago, as are virtually everybody else that we compete with because of the downturn. So the ramp to get to the target is clearly steeper, but the fundamentals of the business are just as we have articulated now over the past year for the investment community.

We have the leverage of gross margin expansion, those levers are all valid and all at work. It is just going to take us a little bit longer to get there. But there is no change in the targets. There is nothing fundamentally different about our business today than six months ago or 12 months ago in terms of our ability to hit that target.

Doug Freedman - RBC Capital Markets

All right. And on the OpEx side of the business, is it sort of as we resume revenue growth, is it safe to assume that we sort of get some spending growth there as well, or are there programs that you put in place going to continue through a period, where you may see actual revenue growth and still have OpEx programs that are kicking in to hold those OpEx numbers down?

Rich Beyer

I think we will not let OpEx grow. I think it is fair to say that we will not let OpEx grow at the rate of revenue growth in the future, when the revenue growth resumes. Some of it obviously we are being very careful about incentive programs and so forth that you can’t do forever, but some of the programs that we put in place have to do with structurally changing things, and operating at a lower level than we did in the past, and some of those things will be maintained. So you can expect that with the return of revenue growth the OpEx will be less than that for some period of time.

Doug Freedman - RBC Capital Markets

Terrific. And if I could, just one about sort of the condition of the market place, where I believe you mentioned that there is still – there is about 11 weeks of inventory in your distribution channel, do you have a target for that, what is it traditionally, can you remind us what it has run traditionally, and where you like to see that level?

Alan Campbell

I will take that one Doug. I would say that the 11 weeks is slightly higher than what we would have targeted. Last quarter we were at 10.5 weeks. I think if we are in the 9, 10 weeks, we feel pretty comfortable from the channel standpoint.

Doug Freedman - RBC Capital Markets

Terrific. Thank you.

Operator

The next question comes from Frank Jarman with Goldman Sachs.

Frank Jarman - Goldman Sachs

Great. Thanks for taking my questions guys. I just wanted to focus back on the microcontroller segment, and specifically on the comments you made around industrial within microcontroller. I think you indicated that that drove most of the weakness in that segment. But I think industrial accounts for about a third of microcontroller, maybe even a little less. So I was just curious if you could give us some color behind the weakness in industrial and then conversely how you are thinking about the resumption of growth in industrial for 1Q. Thanks?

Rich Beyer

Sure. The industrial business for us is characterized by the connectors [ph] family of products that we launched about 24 months ago from a development standpoint, began production in November of this year, the first members of the family. And so we are now in volume production of the connectors family. So obviously it didn’t help us in the early part of the year, the design win momentum has been very strong.

That product is now in production. We are shipping it to customers, and more of the family of products are coming out all the time. So we see that now to be incremental microcontroller revenue for us for the base families of the S08 / S12, (inaudible) and so forth. So, it is plus the fact that the industrial business was down consistent with the drop in our distributor business, and we anticipate we are seeing some strengthening from our distribution customers related to the industrial microcontroller. So that is what gives us the sense that our industrial business should be up honestly in Q1.

Frank Jarman - Goldman Sachs

Great, thanks. That's very helpful, and then just as a follow up, thanks for the color on the distribution inventory. Can you just remind us how much distribution accounts as a percent of sales? I think in the past you said somewhere around like 24%, 25%. Is that still sort of about where I should think it is today?

Alan Campbell

That's correct Frank. It's actually for the year at 23%. It is actually slightly lower than that in the fourth quarter because we did see a more precipitous fall in industrial as Rich just talked about, but for the year it is running at 23%, and Q4 was a little bit lower than that.

Frank Jarman - Goldman Sachs

Okay, great. Thanks very much guys.

Operator

Our next question comes from Jeff Harlib with Barclays Capital.

Jeff Harlib - Barclays Capital

Hi good afternoon guys. Rich, can you talk a little more automotive business, which you are seeing from your supplier customers in terms of inventories and also are you seeing weakness in Europe and relative strength in North America, just a little color on that?

Rich Beyer

The inventories we see are including little bit at our tier one customers. We are getting indications, verbal indications from our customers that Europe is in fact slow, maybe will be down this year. But they are also telling us however that they feel that the US will be up that emerging market like Brazil and China will definitely be up.

Places like Korea continue to be strong. So that's the framework. The reason I say that's what our customers tell us is because as you know, we sell parts to the tier one customers and they put those systems, they put our parts into their systems that go into many markets and they will tell us whether it is going into a vehicle that is built in the US or in Europe or in Asia-Pac.

So we have to rely on what they say about what's happening to the systems, but it's certainly that what I just told you is what they're telling us about the situation. Europe is definitely a place of nervousness. North America is okay, and the other parts of the world seemed to be okay. Japan is improving because it was in a deep hole as a result of the Sendai situation. So that's the framework that we're looking at for 2012.

Jeff Harlib - Barclays Capital

Okay, and just on the plant closures, can you just talk about how the Toulouse product qualifications and transitions are going, and also just the savings have been quantified, the savings realized I think you did that on the 3Q call. What are the savings realized in 4Q and when you should be at the run rate on the Sendai’s saving?

Rich Beyer

Okay, Jeff. I'll comment on the qualifications. The qualifications for the Sendai facility are largely complete, and similarly the qualifications on the Toulouse plant are largely complete. It must be said that the sudden closure of Sendai has created nontrivial demands on us, because we fully anticipated that we would end of life certain products, with sufficient inventories to accommodate our customers' requirements and then transfer other products. Because of the sudden closure we had to in fact really speed up the process of qualifying the parts that we intended to move but also to bring up other processes and products that we never intended.

So it has been hectic, but we're nearly complete on that, and I think we've done a good job to the customers expectation, but that is part of the reason why we delayed the Toulouse closure is because we absolutely had to get these parts from Sendai available into the marketplace quickly, but the Toulouse qualifications are coming to an end. The vast majority of parts are fully qualified and in production, and so we think we are in reasonable shape to close as we – very good shape to close as we anticipated, and I will let Alan answer the questions about when we get the benefits of that.

Alan Campbell

Yes, so Jeff the total benefit as communicated in the past, we expect annualized savings associated with these closures to be 120 million. Of that approximately 50 million was associated with Sendai and 70 in Toulouse. We have been realizing some benefits in Sendai, which is unfortunately an offset with some of the utilizations, and that has helped to keep the margins where they are. We still have a little bit more to go within Sendai. So I think of the 50 million just over two thirds of that has been realized, and there will be a little bit more in Q1 and Q2.

For the $70 million in Toulouse, because we did extend this facility and some of this was end of life inventory, we won't really start seeing the benefit of that until Q4. We will start to see an improvement in gross margin in the fourth quarter and then tail end of 2015.

Jeff Harlib - Barclays Capital

Okay, that's helpful. Lastly just CapEx for this year, should we assume you know, assuming a modest growth environment in the 100 million range?

Rich Beyer

Yes, I think that is fair. We spend about 3% of sales this year, for planning, modeling purposes probably 3% is a good number Jeff.

Jeff Harlib - Barclays Capital

Okay, thank you.

Operator

Our next question comes from Harlan Sur with JP Morgan.

Harlan Sur - JP Morgan

Hi guys, good afternoon and thanks for taking my question. On the wireless infrastructure side of your business you know, with the 3G and 4G wins that you have what's your view from your customers on when the service providers are going to start to accelerate in the case of 4G or reaccelerate in the 3G case. When are they going to see acceleration of deployment which I think last quarter you said first half of this year, is this going to be a contributor to the growth you expect in Q2?

Rich Beyer

We don't expect Harlan, but it will help very much in Q2. We did declare that we do hope that it will be a net contributor in the second half of the year. It will be positive as it rolls out. I think we're seeing more devices that are capable of delivering the experience that (inaudible) including battery life and so forth more becoming available, which we think is part of the chicken and egg scenario with LTE 4G, but we are not banking on anything significant in Q2, but we are hopeful that we will start to see some roll out in the second half of 2012.

Harlan Sur - JP Morgan

Great, and then my follow-up question on the improving book-to-bill trends here in January, any color in terms of it sounds like most of the early recovery that you're seeing here is primarily from your distributors. How much of the strength that you're seeing in bookings is coming from your direct customers?

Rich Beyer

The strength is coming from automotive, it is coming from networking and it is coming from industrial. The distributor is much more of an overlap with industrial. So we're seeing it from OEMs, direct customers in the automotive and the networking space, as well as the industrial investments. So it is pretty broad-based.

Harlan Sur - JP Morgan

Okay, great. Thank you.

Operator

And our next question comes from Ambrish Srivastava with BMO Capital Markets.

Ann Lee - BMO Capital Markets

Hi, this is Ann Lee [ph] calling in for Ambrish. Thanks for taking my call. Just one question, can you outline your expectation for cash flow this year, and what is your target for free cash flow?

Alan Campbell

I will take that question. We’re fairly positive on the outlook for our cash flow as we go into 2012, and we are fairly positive for a number of reasons. One is that we are seeing, we will see an improvement in working capital, but without draining our cash in 2011 associated with some of the end of life inventory builds. We are still to receive some insurance proceeds, which gives us confidence also.

Obviously with the growing market, we will see lot of fall through as communicated in the past, 60% fall through for every incremental dollar of revenue, and again if you look at our past performance, we have actually exceeded that. Overall from a cash standpoint, we are feeling comfortable. I don’t want to be too specific in terms of what the usage of that cash will be, but we feel comfortable that we will be able to generate cash, which gives us a number of different options obviously.

We also will not have the significant fees, if you recall in 2011, we spent just under 300 million as part of the IPO we spent 300 million of our cash (inaudible). When you think about now, you think about the working capital, the insurance proceeds, it does get us confident on the cash front to generate some cash.

Ann Lee - BMO Capital Markets

Okay. Thank you.

Rich Beyer

Okay, operator. I think we need to close the meeting. Let me simply summarize. We think Freescale has weathered this downturn reasonably well. We worked the gross margin, and we believe successfully with the levers that Alan has articulated, we tightened our belt significantly from an OpEx perspective and as a result believe that we have come through this reasonably well.

Q1 is a quarter as we have guided, we expect to be down for the reasons we explained, but the events of the last seven or eight weeks suggest that we are probably through this and Q2 should be positive, and that it is the beginning of – it is the resumption of revenue growth and hopefully gross margin expansion and operating margin and EBITDA, and EPS expansion. So thanks very much for your interest. Thanks very much for your support. We will see you in 90 days again. Okay, thanks operator.

Operator

Thank you. This does conclude today’s conference. You may disconnect at this time.