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Freescale Semiconductor(NYSE:FSL)

Q3 2007 Earnings Call

October 23, 2007 5:00 pm ET

Executives

Mitch Haws - VP of IR

Michel Mayer - Chairman & CEO

Alan Campbell - CFO

Analysts

Lenny Zeltser - Merrill Lynch

Jeff Harlib - Lehman Brothers

Sundar Varadarajan - Deutsche Bank

Guy Baron - Credit Suisse

Patrick Wang - FCM Advisor

J. Montgomery - Morgan Stanley

Heather Campbell - from Barclays

Eric Rubel - MTR Securities

Robert Hopper - UBS

Operator

Good afternoon. Welcome to the Freescale Semiconductor Third Quarter 2007 Earnings Call. All lines will be on a listen-only mode and the call is being recorded. If you have any objections you may disconnect at this time.

I would now like to turn the call over to Mitch Haws, Investor Relations.

Mitch Haws

Thank you everyone and welcome to our Third Quarter 2007 Conference Call. With me as always today are Michel Mayer, our Chairman and Chief Executive Officer, and Alan Campbell, our Chief Financial Officer. The earnings release and financial statements discussed today are available at the Investor Relation section of our website at www.Freescale.com. This call is being webcast live at our site as well.

Today, we will make certain forward-looking statements and these statements, as always, are based on our current expectations and assumptions. Because of the inherent risks and uncertainties, our actual results could differ materially from these statements.

Please review our filings with the Securities and Exchange Commission for a more detailed discussion of the factors that could cause our actual results to differ materially from the statements made today, as well as, other factors that could affect our results.

This presentation is being made on October 23, 2007. It includes time-sensitive information and the Company undertakes no obligation to correct or update any information presented on this call.

During this call we will also reference certain non-GAAP financial measures that we believe provide useful information about our ongoing operating performance. You will find on our website the required reconciliations to the most directly comparable GAAP number.

With that, I will turn the call over to Michel.

Michel Mayer

Thank you, Mitch. Good afternoon. Welcome to today’s call. As you have seen from the press release that we distributed to the audience, our third quarter results improved over the first half of this year mainly due to higher wireless revenues and I’ll discuss that.

Revenue earnings and cash flow were stronger sequentially, and we ended the quarter with over $770 million in cash. Like many of our competitors, and many have already announced their results ahead of us, our results are below the prior year. However, the semiconductor market continues to be somewhat challenging, and despite those challenging market conditions, we continue to perform well operationally with solid margins and cash flow.

We continue to make progress this quarter in strengthening our organization with the appointment of Henri Richard as our Head of Sales and Marketing.

Henri is respected in (inaudible) veteran. I am pleased, he joined the Freescale team. His expertise in developing customer solutions will accelerate our growth initiative and build on Freescale’s strong market position.

Now, let’s look at the quarter in more detail starting with TSPG Transportation and Standard Products. The TSPG revenue was $653 million down from last quarter and down from the prior year.

Now, the segment's revenue were impacted by lower overall IP revenues the planning of which can vary as you understand somewhat from quarter-to-quarter during the year. So if you look at TSPG’s revenue on a product basis, it was essentially flat year-on-year.

Now, if you look at the product revenue, the sales were negatively impacted on a sequential basis by the seasonal weakness in North American automotive production. That production, I remind you, declined 15% sequentially, North American production, as well as, had some softness in distribution. And this offset was consistent with either quarter by the growth that we experienced in Asia-Pac.

And our revenue in Asia-Pacific, automotive grew 27% from a year ago. So we continue to grow in Asia-Pacific. We continue also to see good performance in our 16-bit MCU's, up 18% year-on-year and sensors continued year-on-year growth of the [automobile] segment.

We are also starting to see traction in design wins including analog power management with both U.S. and Korean based companies and automotive microcontroller with some of the world’s largest Tier 1 suppliers. Overall our design win base is 15% above last year, 2006.

We continue to make investments in products and partnerships in TSPG to support future growth. For the consumer market, the RF entertainment control platform that we announced in Q2 has begun to gain traction. 13 of Sony's latest Bravia TV model, which you know are leaders in their segment, and are using these RF platform for their wireless remote control. The technology lab at our Freescale Technology Forum in Tokyo last month featured a Bravia TV with this technology and it generated significant interest from other consumer electronics companies.

We recently introduced the Flexis series of compatible microcontroller that serve as the 8-bit to 32-bit connection point on the Freescale Controller Continuum. The first product of that series which we received accolades in China. Readers of Portable Design China selected Flexis as the best MCU and the devices also received Electronic Engineering and Product award for 2007, plus the influential China Embedded System New Technology award.

In Q3, another 22 new ColdFire devices from the low end to the high end of the 32-bit performance spectrum lines were introduced. We have expanded our ColdFire MCU portfolio by 25% with this launch, which includes 12 high performance microprocessors for Linux application and 10 additional ColdFire MCUs with connectivity and ultra-low-power options for entry level applications.

We unveiled the industry's first tire pressure monitoring system, containing capacitive pressure sensors for ultra-low power consumption and precise sensing. The device combines an advanced pressure sensor with an 8-bit microcontroller, 2-axis accelerometer and radio frequency. This single-package solution is designed to address global safety requirements for accurate, timely tire pressure monitoring.

Finally, we recently announced that we are working with Continental Automotive Systems to design a high performance, multi-core MCU, optimized for electronic breaking systems. This device called: “SPACE”, is the industry's first triple-core automotive MCU. This is the most powerful, sophisticated automotive MCU in its class. It will be used to enable the next generation of electronic braking systems and chassis control systems.

So we are starting to see the result in TSPG of our increased focus on reducing cycle time coming out with more products. We are continuing to focus on that segment and on 8-bit to 32-bit we have more products coming out in distribution in 8-bit, for years this has been our focus to come back and rebound and as we look at our competitor's results we believe they are starting to have an impact.

Switching to networking, the business generated revenue of $315 million in the third quarter, down from last year and from the second quarter. This revenue softness is driven by the ongoing weakness in the communications infrastructure market applications, both wireline and wireless, and you’ve all seen the results of our main customers in the communications and infrastructure space.

If you remember when we entered the year, we thought that we were going to have a weak first half of the year followed by goals in the second half, and what we are observing, I think together with the rest of the industry, is ongoing weakness into the second half of the year, pushing some of the “recovery” to early next year. Those of you who follow the industry know that broadband subscriber growth in established regions have significantly slowed in ’07.

Net subscriber additions being 6% lower in the first half of ’07 compared for the same period in ’06. The mobility of infrastructure market goals has also being flat year-on-year. GSM, GPRS and EDGE will likely continue to source (inaudible) in developing regions, China and India in particular, but it is mitigated by the clients in Western Europe, North America and Latin America.

And finally, together with the other players in the industry we are still seeing the affect of the restructuring of portfolio and investments among our consumers and our customer or customers as well as platform consolidation in this space.

Despite some of the market pressures here, we are starting to see higher backlog, and we expect some improvement in our networking business going forward, simply a little later and little bit slower pace, then our assessment was earlier in the year.

We continue to invest in new technologies in our networking business to support long-term growth, in support of new technologies for wireless infrastructure, Freescale introduced three new devices for WiMAX applications this quarter. The devices extend our portfolio of RFIC to the two primary band utilized by WiMAX throughout the world. These devices also utilize a packaging strategy that reduces growth, size and complexity.

We joined ArrayComm's to offer multi-antenna signal processing reference design for WiMAX based station, based on our quad-core DSP. We continue to introduce new RF product in markets outside cellular infrastructure such as VHF, UHF, broadcast, avionics, industrial, medical and general-purpose RF.

The introduction of our PowerQUICC tool product families of storage enables great performance, integration, security and power management for the storage and printing market.

Jiangsu Yin He Electronics, which is, as you know well, one of China's leading digital television set-top box manufacturer’s, announced selection of Freescale silicon tuner for their digital television set-top box model. This inclusion is significant in digital set-top boxes are being widely deployed over China as the nation migrates from analog to digital television.

While I am talking about China, we opened this quarter a design center in Chengdu in September, in fact. The design center will be sent for the development of our solutions for Chinese local centers, such TD-SCDMA and infrastructure technologies and technical applications support for our growing base of customer in this region.

Finally let’s take a look at wireless and mobile solutions. The Wireless revenues for the third quarter were of $468 million an increase of over a $100 from the second quarter of this year. Our performance still trails with last year given the challenges at our second customer, but we also are making progress in some key indicators.

Profitability continues to improve based on the accelerated operational discipline that the wireless team is implementing under Sandeep's leadership. We continue to be a key supplier to Motorola. At their recent analyst day, they discussed our position as one of their two 3G suppliers going forward.

Freescale content continues to power their new line-up of phones that we are all out to enter in the remainder of 2007 and through 2008. On the multimedia side of that business, we recently returned the WiMAX application processor that powers the new Ford SYNC multimedia platform.

Just recently Popular Mechanics awarded Ford SYNC with a breakthrough award to synchronize product that sets the new benchmarks in design, creativity and engineering. Ford SYNC is one of the only ten products honored in '07.

SYNC which is being developed in association with Microsoft, as you can see on TV these days, is a fully integrated voice activated in-car communications and entertainment system that works with most digital media players and Bluetooth enabled mobile phones.

Our WiMAX processors are also designed [in to soon], the other portable music device, the next generation of which starts shipping this fall. We expect additional design win activity with these devices in other IPs. WiMAX is also gaining traction in Voice-over-IP applications with the other IP point of sale and distribution.

So, in summary, our third quarter performance drove solid EBITDA and cash flow in a average top line environment, I would say and we are very focused as a management team in continuing to improve our overall performance.

Thank you for your attention. I would now like to turn the call over to our CFO, Alan Campbell.

Alan Campbell

Thanks Michel and good afternoon and thank you for joining today's call. Backing Michel's comments our third quarter financial results represented solid improvement over the prior quarter. Revenues were up $70 million, EBITDA was up over $40 million and we had cash balance which increased by $231 million.

Looking at the results in more detail, revenues for the third quarter were $1.45 billion. This represent a 5% increase on a sequentially basis and an 11% decline over the prior year. I'll go into this in more detail, but, as Michel indicated, our wireless business represented a sequential increase whereas all three business segments were down on a year-on-year basis. Our book-to-bill ratio was 0.95 which was essentially flat with the second quarter.

As I review the financials please note that I will be focusing the results excluding the impact of purchase price accounting. We believe, as we've said before, this is a more meaningful representation of our ongoing financial performance.

Our gross margins in the third quarter were 43%. This is down from the same period last year of 46%, as well as from the second quarter. Our internal factory utilization continued to be in the mid 70s. Again, this compares to approximately 90% in the same period last year. And Michel touched on that also -- we also had some head wins with our IP revenues coupled with a higher mix of wireless business resulting in the overall decline.

Despite these head wins, we continue to execute on a variety of the operational efficiencies, including tight cost controls, procurement savings and product yields. We also successfully executed on reducing our operating expenditures.

SG&A in the second quarter was $163 million or 11% of sales. Continued cost control in this area resulted in an expense reduction on a year-on-year, as well as, on a sequential basis.

R&D in the second quarter was $270 million or 19% of sales. This also represents a decline from last year, as well as from the second quarter. As you’ll recall, we implemented a number of cost actions in the second quarter, including announcing a reduction in headcount by about 700 people worldwide. These are approximately two-thirds complete. Now, going forward, we expect these actions to generate additional cost savings of $55 million to $65 million. These savings are spread among the cost of sales G&A and R&D and other income statements.

Adjusted operating income, excluding again the impact of purchase pricing and merger expenses, was $195 million or 15.5% of sales. Again, this was down from last year, but as an improvement from the second quarter of 11.6%.

Overall, the EBITDA for the third quarter was $353 million or 24% of sales; a 42 million increase from the second quarter. Adjusted EBITDA was $396 million or 27% of sales for the quarter. And then on a trailing 12-month basis it was $1.6 billion or 27% of sales. Finally, we managed capital expenditures during the quarter to $73 million or 5% of sales, which is essentially flat with the second quarter. This level of expenditure covers our base maintenance requirements, and we'll address additional expenditures as business conditions warrant.

Now looking at the segment revenues and profitability, Michel has touched on this, transportation and standard products in the third quarter was $653 million, a decrease from the prior quarter and down slightly from last year. Revenues were negatively impacted by seasonal weakness in automotive and a slowing trend in revenues of our distribution business. This segment, however, continues to generate solid profitability with EBITDA of $177 million or 27% of sales.

Our networking business reported sales of $315 million, also down from the prior quarter and below last year due to lower levels of expenditures amongst the major wireless infrastructure providers. NCSG's EBITDA for the quarter will also continues to be very strong at $103 million or 33% of sales.

Finally, our wireless business reported sales of $468 million in the third quarter, up over $100 million from the prior quarter, but still down from the same period last year when it was $540 million.

EBITDA for the quarter also improved significantly in this business to $71million or 15% of sales; actually the highest return on sales in this segment as generated income type. This improvement was driven partly by higher revenues, however, we are continuing to make solid progress in improving the segment's profitability with good execution costs and other operating efficiencies.

Let me now turn to working capital, inventory days declined as we expected from 103 days in Q2 to 92 at the end of Q3. This decline was driven by the improvement in the wireless revenues during the quarter. Our distribution inventory continues to be well managed with units at the end of the second quarter at 9.8 weeks, in line with the first quarter of 9.9 weeks and this continues to be within the range of historical averages.

DSOs were 31 days in the third quarter, down from the first quarter of 35 days. Payables were at 46 compared to 53 in the second quarter. Overall our working capital as a percentage of sales was 16% for the quarter, consistent with the second.

With respect to cash, we executed well. We ended the quarter at $772 million compared to the $540 million at the end of the second quarter. Free cash flow generated in the quarter was strong also. Going forward we believe we have adequate cash and operating cash flow to fund our business for CapEx and our ongoing debt payments.

In summary, a very solid performance and a good progress over the first half of the year and as Michel touched also on the continued opportunity for improvement.

That concludes our remarks and now we will be happy to entertain your questions and I will pass it back to the operator.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Lenny Zeltser from Merrill Lynch

Lenny Zeltser - Merrill Lynch

Hey guys, couple of questions. First off, I was surprised at the instruments in your wireless business. I know you touched on a little bit in your comments but if can expand on the revenue side whether there is some increased customer wins or were other programs are ramped up so you can expand on that a little bit? And then the margins also were very strong if you can get into greater specifics about what drove the improvement in wireless there?

Michel Mayer

Okay, Thanks Lee, I'll take the question on revenue and then I'll let Alan, talk about the margin. First of all this industry is -- this is one of the first times where we are reporting significantly ahead of Motorola, they are reporting a quarter in two days and so we are going to be a front disclaimer. So we are going to be extremely cautious on in this call on what we say or don't say, so I'd just say if you think which is one, we've said several times that our own revenue because of inventory management and lead times and as a component supplier is not necessarily linked quarter within the quarter to the business of our customers. Well that's first comment there is not a direct correlation for every given quarter.

The second thing is all that you can probably make the assumption that our business went down really low in the beginning of the year as our customer put the foot on the brake and that we are probably getting back towards more a normal inventory management situation. But that does not say anything on what their business is doing or not doing.

And the third thing is yes, we are hunting some other businesses, but again I apologize, I'm being a really -- I am not giving too much visibility, again, because I am worried given the size of my business, I can't go into about the overlying in that space, but if I give too much color I would be guiding quite indirectly.

Lenny Zeltser - Merrill Lynch

Okay and then on the --

Michel Mayer

The second thing is to Alan on the margin and you will get additional information within that space.

Alan Campbell

Yes. Thanks. Let me -- I think the equation was specific to our wireless business on margins with our significant improvement on EBITDA at over 15%. Despite the head wins, I talked about of utilization and lower IP, we continue to see some very solid execution within our wireless business under the leadership of Sandeep. So really, its one off execution with operational efficiency, product costs, procurement and higher revenues obviously had an impact also.

Michel Mayer

So when Sandeep came on board, he embarked into a wholesale operational, sort of an operational improvements, increased discipline, tightening a lot of things, in particular, yields, sourcing and procurement of some packaging, I mean, things like that and so those things have started to kick in at the beginning of now. Last quarter, our revenue was the -- the impact of revenue was so important that, although there was some beginning of improvements, we couldn’t really see it in the P&L. Now, that the revenue is going back to enhance your level and then we are also have three months later in, and some of those improvements are accelerating, it is much more visible. Had we been, if we have to had a more regular almost pretty straight level of revenue, you probably would have observed those improvements on a marginal basis because of the unusual pattern that we've followed,. I think, it's more visible here in this quarter, and quality comes as a little bit of a surprise, I agree.

Lenny Zeltser - Merrill Lynch

Okay, just one other question, real quick, I think you mentioned the book-to-bill was 0.95, we are probably two-thirds away through the quarter, as this was mentioned, so that lesser than two-thirds of the way through the quarter, what's been the tone of business in your different end markets, and would you expect more churns business in this quarter versus Q3?

Michel Mayer

Well, first of all the 0.95 is a little bit misleading because wireless book-to-bill is lower than the two others, and you have to do again -- it has to do with the credibility of one large customer or agency than and the timing of when in our agreements they finalized their orders. And so it has everything to do with the actual health of that business going forward, but the point it is default stability, so if you look at consultation and networking Alan --

Alan Campbell

Yeah, transportation was 0.97, but networking was 1.08.

Michel Mayer

Yes, very positive. So that's the first element of answer which is that we see -- we are cautiously optimistic of the tone in the wireless end market. Wireless, again, let me not comment, but I think you have enough points of reference on the overall market to know that it continues to be good volume pressure on ASPs and more growth at the low end then in 3G, I mean, that's the net. In automotive, we continue to see a year-on-year decline in the U.S. automotive production level, but we see, I would say, a cautious environment in Europe and good environment in Asia. And then in transportation we are, we feel it's a combination of design wins that we've had and the consumer industry that we see which again have been lower in Q3 although in fact we moved a little bit slightly in Q4 over Q3.

But in general I think we see a good recovery in fourth. We cannot reach that recovery because again the rate is going to a bit down on this, but improvement in the second half being more muted and slower growth than was, this occasion was one or two quarters ago and looking at '08 early part of '08 we will try to have some visibility. We again see single-digit growth and depending on the segment more or less ASP pressure.

The volume they are usually, it's really more a question of ASP pressure. Okay, thanks Lee. Next question please?

Operator

Thank you. Jeff Harlib from Lehman Brothers, your line is open.

Jeff Harlib - Lehman Brothers

Hi Michel. Can you talk to me about progress with other handset customers besides Motorola. You talked about one ramp this year. I'm just wondering how your platform based products are being sampled and potentially [separate]?

Michel Mayer

We continue to work at a slower pace than I would like, but we're making progress, we are ramping up with one customer. And we are in final platform innovation with another one both for our 3G platform and we continue relentlessly to push our platforms.

Jeff Harlib - Lehman Brothers

Okay, and on your capacity utilization side, operating in the high 70's are you looking at your manufacturing facilities for potential rationalization and, also, if you can comment on your equipment from a Crolles JV, whether that gets monetized?

Alan Campbell

Yes, Jeff, obviously I think we've shown from our experience in past that we continue to be proactive in looking at our structure. We have communicated our intent with one of our sections, facilities in Europe and we have also communicated intent as you said with Crolles. But we continue to look at our footprint or factory footprint obviously to optimize our financial performance. And again they didn't come over despite the fact our utilization, we are on the mid 70's and despite the fact our IP's were very low. We really are continuing to execute on voice control operation with efficiency front.

Jeff Harlib - Lehman Brothers

Okay, and last question just the, can you talk about your initiatives to grow sales and distribution, I know I was wondering about growth initiatives. Just can you comment on that?

Alan Campbell

Yes distribution we have said actually speaking in spite to when we took the company public, distribution was the key area of focus and continues to be a key area. We did not see distribution growing and in fact it was basically flat specifically during the third quarter as they managed their end markets as well as the elementary. Within the organization, I think, the very part Michel’s thoughts were honorary who has got tremendous expertise and focus specifically in that channel. So we have a very high expectation of continuing to execute on a distribution business, and you know the growth in 2006 was very poised with ’05. So again both are common distribution, but there is certainly opportunity there.

Michel Mayer

It remains a key goal initiative for us. We have “plateaued” a little bit here. It’s in a combination of the market, but also the fact that we have benefited from lot of the initiatives we took in the spaces while we introduced new products. We need to introduce a new wave of the solution timely products which -- that’s what I was alluding to when I said in 1 we are continuing to introduce more and more products. We took the initiative a year and half ago, two years ago to refocus on some segments where more of the solution finally on lower hand. More integration of IT on our cost reserves, as we had not been focusing on those segments, and we had to let some of our competition get ahead of us over the prior years.

We did start to introduce new products. We have been focusing on a solution. We have been growing. In order to get to the next level of growth to start to grow, if we are to continue to grow faster than the market, like we intend to, we need to get into new set of initiatives. So its going to be a combination of new products coming in at an accelerated pace, as we are continuing to improve our efficiencies in R&D and reduce our cycle time for products in production, and then the next level of sophistication in hiring the eco system and hiring the solution, and again they are to repeat what Alan said, I have lot of expectations on the side Henri is going to get us to now be world class. I am convinced in the side of marketing.

Jeff Harlib - Lehman Brothers

Great. Thanks very much.

Michel Mayer

Thank you. Operator, next question?

Operator

Thank you. Sundar Varadarajan from Deutsche Bank, your line is open.

Sundar Varadarajan - Deutsche Bank

Okay, thanks. I have a few questions, first on the IP side you said partially the costs were somewhat softer sales on the TSPG business, is that something that you'll recapture in the coming quarter or is that like a one-time thing, that was miss, how do we kind of read into that IP revenue that was kind of little lighter in the third quarter?

Alan Campbell

Yeah, I think we have said that the IP revenue which is embedded in each of the businesses can’t be somewhat lumpy. Last year our IP revenue for Q3 was close to 5% of revenues, but this year it’s less than 1%, but I have given specific guidance for Q4, there is an option of possibility we could see some IP coming back again in the fourth quarter.

Michel Mayer

The IP revenue is not a steady revenue and there is a portion of it that’s steady, and this is in middle of the quarter and then the bulk of it is really "dealer related." And so, it's a function of when we close a new licensing agreement, something like that and we don’t really -- So it just happened one year that it is, some of this is commuted and more even and in some years it's an even, that is it just is. So at a high level, yes, you can expect that we will "capture" or to use your words, some of these fervently. If you sit back and look at our overall IP from the new over the year it's very steady. But this one is a little bit uneven.

Now, we usually don't talk about it and we don't point to it. The reason this time where we are using it, because it really is impacting TSPG objects and so we didn’t want you guys to think that our TSPG revenue was going down, but it is not, it is flat year-over-year which is in today’s market is not great, but is honorable. And so we wanted to convey that and not mislead you in a sense in what was happening.

That being said, we are expecting volatility in our IT revenue and when it is not leading to a [probable] income of the object we usually don’t talk about it.

Sundar Varadarajan - Deutsche Bank

Okay. And help us understand the book-to-bill ratio because you have mentioned in the past that it’s not much of a predictive. But you kind of spoke about book-to-bill ratios being above one in the NCSG business, kind of close to one in the TSPG, but last quarter we entered the quarter with book-to-bill being kind of above one for both these segments, yet revenue was down sequentially. So what exactly do we take away from these book-to-bill ratios?

Alan Campbell

You have to use the book-to-bill ratio in conjunction with a number of other metrics that we look out. For example [myblog] is on the book, funds business, lead times. So that’s no misleading in itself, but one has to look at it in a range over which the industry tends to use book to bill as an indicator and general management team here continues to look at a number of metrics as a predictive for following quarters.

Michel Mayer

And it’s a timed indicator and if business in particular for networking this quarter, clearly we didn't see the usual terms that we see in the quarter and that's something that the book-to-bill is not going to show you and so -- I mean, I don't need to explain to you guys what's happening in that space and you can see what Crolles and competitors than in other Nokia, Siemens are announcing and doing, so it is a really slow -- the infrastructure market is really slow at this point, so we didn't see the terms but -- go ahead.

Sundar Varadarajan - Deutsche Bank

And on the wireless side clearly you guys in the first half, whatever inventory collections at your big customer, so you are performance seemed a lot worse than what they were kind of projecting in this quarter. We don't know what they are going to say, but seems like there is some lumpiness here. But if you were to look at your performance for the first nine months as a whole, do you think it's captured, what's going on at your big customer number one. And when we look at year-over-year performance at least do we think things get better from here or how do we kind of look at it from a year-over-year performance going forward?

Michel Mayer

That was an elegant attempt to make me not respect my pledge. Do not guide, but I'll take a joker on this one, okay, thank you. Operator, next question.

Operator

Thank you, Guy Baron, from Credit Suisse, your line is open.

Guy Baron - Credit Suisse

Hi, there. All right, let me actually ask another Motorola question, I'll try my luck Michel. I would have sort of anticipated that your shipments into Motorola, rather into Motorola’s new handset line would have ramped this quarter. If for no other reason it simply for them to sort of fill shelves and be in the markets that they’ve already talked about being in now, was that really the largest driver of growth in this segment, and then, I guess, the part two of that is can you may be reconcile some of that potential volume ramp with the fact that utilization was relatively flat in the quarter?

Michel Mayer

Yeah, I am not sure I understood the second part of your question. Remember we had -- if I do remember we had a lot of inventories sipping on the ship, but remember, we were, if you followed the previous episodes, we were kind of surprised a little bit on the down term like a lot of people in Q1, and a little bit in Q2 by the down turn of our customer and so that created an inventory position. So you can’t necessarily correlate utilization with our valid shipments. If anything, if you had it correctly, our shipment is increasing in each country. But it came mostly out of inventory which we had created before, so that’s -- if you look at the high level we’ve played the role of keeping a higher level of inventory that usual for our customers and so on during that. I mean if we could look at it that way in a front. On the first question, again, I understand I am not giving you the readability you want, but I have to, I really have to be ultra sensitive and I am willing to have a discussion with you guys, also they recall and give you much color, but here I don't want to. Have another question?

Guy Baron - Credit Suisse

Yeah, just to clarify then to make sure I understood the answer, so in essence until existing inventories are depleted only 3G product ramp would actually drive significant increase in volume?

Alan Campbell

Hi, this is Alan. I don't think that’s what we said, we are being somewhat cautious about making any comments on Motorola or our wireless business, specific to Motorola. Michel's comment was very clear, although that we did have a significant inventory reduction and position when we entered the third quarter, and we did then reduced our inventories from 102 days to 93. Again, I think it's appropriate that we take more or give more granularity after Motorola’s analysis.

Guy Baron - Credit Suisse

Okay, and then Alan, let me -- a quick question here, you've talked in the past about using a number of 20% of the drop in utilization to sort of gauge the negative impact on your gross margins, and that could happen with 3% drop in gross margins, would that be the same measure to use on the way up?

Alan Campbell

Yes, absolutely. I think actually if you look at, as I said, to emphasize once again that the utilization rates coupled with the IP, that’s a significant pressure on our margins, but we will able to counter off with some very strong operational efficiency and focus.

Michel Mayer

I want to add one element of complexity; I want to have for the discussion here, so that you guys get a little bit careful in the conclusion that should help. As we are in a exiting call, we are positioning some of those products which we were running in Crolles into other surface and for most of those products it's foundry, which you don't see in our internal utilization. And so that is that’s when I said, because in particular in Q4 -- I mean we are not going to take product out of Crolles after the end of the year, which means that we've pretty much stopped running wafers, new wafers into the quarter as of now. We are just now going to get in Q4 wafer that we had started in Q3.

And so I don't want to get in more details, but and then try a little hawking of some foundry, so if you have and things like that can give you three or four more that will de-correlate if you want our internal utilization, particularly in the wireless phase with what's happening to us in term of the product. So you need to wait for Q1 when we are really more steady state of not having the call capacity, it being unused here in essence “to see what our new steady utilization” is going forward.

Guy Baron - Credit Suisse

Okay. And then just finally a quick one on cost saves. How much of the cost saves have you talked about were actually realized this quarter in the number and then going forward I see you've only got a 6 million add back there. Does that represent just a balance of what you've done already and over what timeframes do you really execute on the rest of that 35 to 65 in savings?

Alan Campbell

Yeah, we are executing the remainder of the as I'd say this quarter we have executed on our 60% of the actions already. The other 40% are driven by specific issues in specific countries, but that will take us into Q1 and Q2, where we'll continue to see cost savings.

Michel Mayer

Okay, thanks Guy. Operator next question please.

Operator

Thank you. Patrick Wang, from FCM Advisor. Your line is open.

Patrick Wang - FCM Advisor

Yeah, thank you. A couple of questions, the cash increase of $240 million, your free cash flow from operation is only $120, so where does the other $100 million come from, is that from tax refund of something one-time?

Alan Campbell

No, Patrick, the cash really was driven by three elements, one was the working capital. We talked about working capital in terms of the inventories, the receivables as well the payables and that was a benefit. Two was, improvement in our operating performance that was driven by EBITDA of $40 million and three was, some interest payments with the flow of interest payments that we have. These are the three elements that drove the improvement that worked out in cash of $240 million.

Patrick Wang - FCM Advisor

Right. So, the working capital was 16% of sales and what was that last year same period?

Alan Campbell

Last quarter that was 16% of sales I don't have the number, I think it was actually at 14% of sales last year, but again we have to be careful there because when you look our receivable balance, a lot of it depends, it is a function of the timing of taking that cash from revenues for that specific quarter.

Patrick Wang - FCM Advisor

And how much of that cash flow is actually from the working capital reduction this quarter, can you just magnitude close to 100 or close to 40?

Alan Campbell

Yeah, that was approx, it was just over $30 million of working capital improvement.

Patrick Wang - FCM Advisor

Okay, great. And a question is for modeling purpose your CapEx as a percentage of sales had dropped quite a bit from last year, 11% to 5% this year. Is that all because Crolles or is there a nature of CapEx will come down, and how do we model that going forward, is 5% a pretty realistic number?

Michel Mayer

Well it has a lot to do with being at 90% position in ‘07 at the right time. We are -- as we’ve observed our utilization going down, clearly we are not adding capacity here at this point and so we have moved down to a maintenance level of CapEx as Alan indicated, so modeling forward I think a 6% --

Alan Campbell

Yeah, 6% - 7% is pretty reasonable for modeling, a lot depends on obviously the market conditions, the revenue, you know, -- as a responsible when it comes to taking actions on what can capital or expenses, so in order to the capital at 5% and this quarter was low, but for our modeling purposes we have just said before Patrick, I think 6% plus is reasonable.

Patrick Wang - FCM Advisor

Okay. Great. Thank you.

Michel Mayer

Thank you. Thank you, Patrick. Operator, next question?

Thank you. J. Montgomery from Morgan Stanley, your line is open.

J. Montgomery - Morgan Stanley

Hey, gentlemen. The revenue sequentially, I think, was up about 5.1%? Was there any positive impact in there from the weak US dollars?

Michel Mayer

So, let me just, throw a little bit of color on the currencies for the company. We are probably over 90% naturally hedged and basically what I mean: as the expense in sales comes with a natural hedge, was there any impact? On the sales line, there is slight positive impact, on the expense line there is a slight negative impact. Overall, though it’s minimum, again 90% is a natural hedge.

J. Montgomery - Morgan Stanley

Okay, so could you just tell us what sequential revenue would have been without currency?

Alan Campbell

I don’t have the number; Jan, I need to get back to it. It's not significant; I can tell you that you while I need get back to on this specific number.

J. Montgomery - Morgan Stanley

Okay. And did you guys publish a cash flow from operations number?

Alan Campbell

We will publish a cash flow from operations, we will be listing, now be issued on our Q in the coming days. So, you don’t see the detailed financial statement.

J. Montgomery - Morgan Stanley

Okay, can you just tell what's their number is?

Alan Campbell

The free cash flow from operations will be $337 million in that range.

J. Montgomery - Morgan Stanley

$337 of cash from operations?

Alan Campbell

That's operation cash flow, yeah and that excludes any interest, any CapEx.

J. Montgomery - Morgan Stanley

Right. Okay. And in terms of seasonality from the third quarter to the fourth quarter, looking back at the historical trends, it’s kind of difficult to get a pattern, would you mind walking us through what you would consider a normal seasonality for each of the business segment from the third quarter to the fourth quarter?

Alan Campbell

Yeah, I think historically we have seen that, and again it varies by business with that conduit and it varies with the market conditions. Historically, transportation business is channel sales, slightly increasing going into the fourth quarter. The third quarter is ordinarily a low point for that. In our networking business, the seasonality historically has been flat to slightly up.

And as Michel touched, we have seen very seasonal patterns where the first half is weak, second half was strong. We didn’t see that in the third quarter, but the general statement, I think, it’s fair to say that networking will be flat, and up in the wireless business, it'd also be slightly up going into the fourth quarter.

J. Montgomery - Morgan Stanley

Okay. And I am going to try one on Motorola -- the revenue that Motorola usually contribute to this roughly 20% to 25% of the Crolle business, and usually about two-thirds of the wireless business. Any reason to believe that would be materially different in the third quarter?

Alan Campbell

Again, I don’t think it’s appropriate that we have any specificity at this point Jay on Motorola and again, yeah, sure we'd be happy to take follow-up questions and give further details on granularity, one is Motorola that I mentioned.

J. Montgomery - Morgan Stanley

Okay, thank you.

Alan Campbell

Thanks, Jay. Can we go the next question.

Operator

Thank you [Heather Campbell] from Barclays, your line is open.

Heather Campbell - from Barclays

Yeah, thanks. Most of my questions have been asked already. But just two other quick last ones, could you give us a breakdown roughly of whether your business that was in-house versus outsourced for the front end and backend in the quarter. Do you have that available?

Alan Campbell

Yeah, actually those two elements of this is what we call the, on Silicon stage of the front end, our outsourcing actually increased in third quarter and increased with 17% of sales. So, up from the 13% range in the second quarter, and that's driven again primarily by the technology needs of our wireless businesses and the growth there. On the assembling test for backend state of the equation; that's been pretty consistent with 50% inside and 50% out.

Heather Campbell - from Barclays

Okay, thanks. And then secondly, could you give us an update if there is one on the progress of the East Kilbride and then some of the facilities there, just maybe if you could give us some color on what you are seeing in terms of level of interest, anything along those lines?

Alan Campbell

We have a level of interest. We have engaged with an outside company called Colliers and we are going through some diligence at the moment with those interested parties. So, I think for confidentiality that's probably all I can see at this point.

Heather Campbell - from Barclays

Okay. That's it thanks.

Alan Campbell

Okay thank you. Operator next question.

Operator

Eric Rubel, from MTR Securities, your line is open.

Eric Rubel - MTR Securities

Hi, good afternoon gentlemen, thanks for taking my call, and Alan a couple of questions for you quickly. The IT revenue is this, shall we think, this is sort of a royalty that has the 100% gross margin?

Alan Campbell

The royalty revenue was probably 70% plus gross margin are 100%. There are costs associated with that.

Eric Rubel - MTR Securities

Okay.

Alan Campbell

Growing our business is still a very positive gross margin.

Eric Rubel - MTR Securities

Great and then another one for you Alan, if is it possible to kind of refrain expectations around what the possible size of the assets sales could be if you had the factor in [Celbridge] and the 300 millimeter shell and the Crolles equipment, is there can you give us a sense of or range as to what those assets could bring in and then with one side and then if you [Celbridge] were to be closed what that would do on the operating side?

Alan Campbell

It's actually my hometown so if I can correct you, its called Kilbride, you see that, I know it is wrong to see that, but then the intent there is it will take some time, that's not intended for short turn at this point but we can turn ourselves more so just for clarification there.

Eric Rubel - MTR Securities

Okay.

Alan Campbell

And that will help with overall utilization as well as our margin structure. In terms of significant improvements on our margins as a result of that however you will not see and we will not see significant improvement until the end of '08 going forward.

Eric Rubel - MTR Securities

Okay.

Alan Campbell

In terms of the cash realization for some of the items, again that we are looking are including Crolles, we are currently in discussions and working with our partners in, I think it’s appropriate not to be, for confidentiality and respect, develop two partners that we wait until we have finalized the agreement which should be in the first quarter.

Eric Rubel - MTR Securities

Okay.

Alan Campbell

Of next year.

Eric Rubel - MTR Securities

And if I could from Michel or Sandeep, if he is available, you know, away from sort of the Motorola impact to the wireless segment, could you guys talk about the non Motorola components and in terms of day spend and on the other side of the business, any color sequentially or year-over-year will be helpful?

Michel Mayer

Eric, I am not sure I have that level of detail available with me here. At a high level, what we have year-over-year, you mean, revenue comparison for the non-Motorola?

Eric Rubel - MTR Securities

Right.

Michel Mayer

Well, it’s up year-over-year. I -- we announced this as we are hoping us win and their volumes are going up. We are seeing a positive effect of that, but again I am -- I have said earlier to an earlier question that I was not going to guide on non-Motorola piece who specifically because then you would know what the Motorola piece is, then would lead you to be able to A minus B equals C. So, I respectfully take a second joker.

Eric Rubel - MTR Securities

Okay.

Michel Mayer

Okay. Thank you operator. Next question?

Operator

Thank you, Robert Hopper from UBS. Your line is open.

Robert Hopper - UBS

Thank you. Two things on my end, one if you go back to the last quarter on networking business you guys definitely were pretty positive, and we all know what’s happened since then, just from a infrastructure perspective, what gives you guys more confidence, even though you have a pretty decent book right now, that it is actually going to transfer into revenue in the near term? Or is it something that we should be expecting to develop into revenue, sort of in later in first half of '08 or beyond, that's just firstly?

Alan Campbell

Hey, Robert let me take that one. The revenue on networking -- the book-to-bill is positive for what we said earlier, well, I said earlier it’s not just book-to-bill, it's also backlog in our metric. We are seeing a backlog today, relatively stronger than it was in the past. So these are two indicators that we see some kind of -- some strength there. Again, I think it's important to say that particularly in light of some of the other announcements worth some of the customers, we are cautious on it with them.

Robert Hopper - UBS

Okay. And then, all my other questions were taken up, but just one request, given all the questions have been revolving around your wireless business and you are one large customer, any chance to request that you can hold your call next quarter after they report, that's a question?

Alan Campbell

That's a good point and we are thinking about that, but we don't necessarily control the scheduling here.

Michel Mayer

Okay. Thank you. This has been a good set of questions. Thank you very much for your time. Operator, we've done. Thank you. Bye-bye.

Operator: Thank you. That concludes today’s conference. You may now disconnect from the audio port.

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