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Freescale Semiconductor Inc. (NYSE:FSL)

Q1 2012 Earnings Call

April 19, 2012 5:00 PM ET

Executives

Mitch Haws – IR

Rich Beyer – Chairman and CEO

Alan Campbell – SVP and CFO

Analysts

John Pitzer – Credit Suisse

James Covello – Goldman Sachs

Ross Seymore – Deutsche Bank

Doug Freedman – RBC Capital Markets

Harlan Sur – JPMorgan

Stacy Rasgon – Sanford Bernstein

Jake Kemeny – Morgan Stanley

Operator

Welcome to Freescale’s First Quarter 2012 Results Conference Call. All lines have been placed in listen-only mode until the question-and-answer session. Today’s call is being recorded. If anyone has any objections, you may disconnect at this time.

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

Mitch Haws

Thanks, Kim, and welcome to all of you to our first quarter 2012 earnings conference call. With me today is Rich Beyer, our Chairman and CEO, and Alan Campbell, our Chief Financial Officer. Before we begin today’s prepared remarks, let me remind everyone that today’s discussion does contain forward-looking statements that are based on our current outlook and as such they will include certain risks and uncertainties.

Please refer to our press release our Form 10-K and other filings with the SEC for a more detailed discussion of the specific risk factors that could cause the actual results to differ materially. Also, we will reference certain non-GAAP financial measures and we will post the appropriate GAAP financial reconciliation’s to our website at freescale.com.

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

Rich Beyer

Good afternoon and welcome to our first quarter conference call. I will take a few minutes to summarize the highlights of the quarter after which Alan will provide more details on the financial results then I’ll provide some highlights on our target markets followed by our guidance for Q2. Q1 was challenging but didn’t mark what appears to be the end of the sequential declines in revenue we’ve experienced on the past few quarters.

As we had in prior quarters, we managed gross margin and operating expenses effectively allowing us to deliver a overall results consistent with our outlook in the consensus. Looking at some of the specifics revenues were $950 million, which represented a decrease of 6% sequential.

Gross margins were 42.3%, a 160 basis points below Q4 well above the TARP we saw in gross margins during the last downturn in 2009. This performance generated an adjusted net loss of $9 million and a loss of $0.04 per share. We did see booking strengthen in the quarter and our Q2 backlog improved over Q1 levels entering Q1 in January.

Now Alan will provide additional details.

Alan Campbell

Well good afternoon and thank you again for joining today’s call. As Rich said, Q1 was challenging while we continued to executing well on gross margins, operating expenses and cash. As I review the financial results in more detail, please note that I will be focusing on the results excluding the impact of sales in one-time items and adjustments. We believe this to be a more meaningful representation of our ongoing financial performance.

Please also note that the majority of the purchase accounting adjustments along are highlighted and the adjustment – such adjustments are no longer materially. In addition recalled on the 1st of January of this year we realigned our operations to create two new strategic product groups, Networking & Multimedia Solutions NMSG and Automotive, Industrial & Multi-Market Solutions AISG.

The NMSG includes our networking processors, our application processors on radio frequency products and AISG includes a microcontroller and analog and sensors products. We reported our sales consistent with the two product groups beginning this quarter. We have included our quarterly history of revenue by-product group on our website. We are looking at Q1 in more detail. Q1 was $950 million representing a sequential decrease of 6%. Sales declined by 20% compared to Q1 last year. AISG product sales in Q1 were $527 million, 4% below the fourth quarter and 15% below Q1 of last year.

Automotive sales declined both sequential and year-over-year due to slightly elevated inventory levels at some of our customers and weakness in European production. Sales in our industrial markets increased sequential but declined year-over-year due to the strong start we saw in early 2011.

NMSG revenues were $317 million in the quarter down 16% from Q4 and down 20% from last year. The primary driver of this sequential decline was seasonal weakness in our consumer business along with declines in our RF business due to elevated inventories as several networking customers our digital networking business is worst lately on a sequential basis. And year-over-year networking revenues were negatively impacted by lower demands and pockets of elevated inventory mainly in the wireless infrastructure market.

Cellular product sales were $66 million compared to $41 million in Q1 and $138 in the first quarter of last year. Other products which consists primarily of foundry sales and IP revenue, resulted in quarterly net sales of $40 million compared to $46 million in the fourth quarter from $39 million last year.

Finally, sales to distribution increased 14% sequentially and were down 17% compared to Q1 last year. Recall that the first half of 2011 was quite strong in the distribution channel. Our book-to-bill ratio in the first quarter was 1.05 this compares to the fourth quarter of 0.92.

Now, looking at gross margins and operating expenses, our gross margins were 42.3 compared to 43.9 in the fourth quarter. Our margins were negatively impacted on a sequential basis by lower sales volumes and product mix, but we managed to partly offset the impact through operational efficiencies, procurement savings and lower depreciation.

Compared to Q1 last year, adjusted gross margins were down 230 basis points, primarily due to lower sales volumes. Our internal front-end factory utilization was approximately 81% in the first quarter. This compares to 80% in Q4 and 74% in Q1 of last year.

Now, looking at operating expenses, we continued to execute very well and effectively managing our operating expenses. SG&A was $102 million or 10.7% of sales, below the fourth quarter on a percentage basis and consistent with our target operating model. Total SG&A dollars declined $11 million sequentially as we managed discretionary spend as well as incentives. Our SG&A dollars were down $29 million in Q1 from the same period last year.

R&D in the quarter was $181 million or 19% of sales, slightly higher than a decline in sales. Total R&D spend declined $7 million from fourth quarter due again to managing our discretionary expense, R&D also declined $21 million from Q1 of 2011 due primarily to lower compensation incentives.

The level of investment in R&D continues to support the growth initiatives we’ve targeted in our core market and product areas. Adjusted operating earnings excluding the impact of purchase price accounting and other items were $119 million or 12.5% of sales. This compares to$144 million in Q4 and $201 million in the first quarter of last year. Our adjusted net loss was $9 million exclusive of reorganization charges, stock based compensation and adjustments included in today’s earnings release. This compares to net earnings of $18 million in Q4 and $57 million in Q1 of last year.

The adjusted net loss per share exclusive of the adjustments mentioned earlier was $0.04, compared to an adjusted net earnings of $0.07 in Q4 and $0.29 in the first quarter of last year.

EBITDA in the first quarter was $183 million or 19% of sales and this compares to $216 million, 21% of sales in the fourth quarter and $287 million or 24%t of sales in the first quarter of last year. Our adjusted EBITDA was $1.12 billion on a trailing 12 months basis. We did make progress in Q1 with working capital, which represented a $10 million source of cash in the quarter. Our AR days of sales outstanding were 41 in the quarter. This compares to 41 in Q4 and 36 in the same period last year.

Payable days were at 57 compared to 55 in the fourth quarter and 54 days in the Q1 of last year. And inventory dollars, our inventory dollars were up modestly from Q4 $13 million in total and total inventory days were about 134 compared to 126 in Q4 and 101 days in Q1 of last year. The increase in dollars and days was related primarily to inventory builds associated with the closure of our Toulouse, France facility.

The distribution our inventory was down 4% or $50 million compared to Q4. Weeks of sales and distribution decreased from 11.1 in Q4 to 10.7 in Q1. Cash and cash equivalents were $760 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 $20 million or 2% of sales. During Q1 we received cash payments of approximately $61 million related to an insurance claim for the business interruption following the earthquake in Japan and the impact on our Sendai facility.

In total we have now received $150 million of proceeds related to this claim. Also during Q1 we refinanced $500 million of subordinated notes with a coupon of just over 10% with our new term loan. Based on current LIBOR, the rate of the new term loan is 6% and annual interest savings based on the current rate will approximate $20 million beginning in Q2 and that is $20 million on an annualized basis. Our cash cost of approximately $59 million related to call premiums accelerated interest payment and all other related fees and expenses.

Given our consistent execution on 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 our capital expenditures and continue to delever. Our net debt is approximately $5.8 billion.

Finally, I want to provide a brief update on the progress we’ve made today on the closure of our two remaining 150-millimeter wafer fabrication facilities in Sendai, Japan and Toulouse, France. Recall that we planned to generate $120 million in annualized savings when we complete the closure of these facilities and transition to our 200-millimeter factories.

The process of completing the transition from the Sendai facility is substantially complete following the accelerated schedule we started in March, following the earthquake. The Sendai facility was not reopened for production after this tragedy in March of 2011. At this time, most of the product qualifications and transitions have been completed.

Given the early closure of our Sendai factory caused by the earthquake, we continue to see some accelerated benefits in the first quarter and expect a majority of the $50 million in annualized savings to be reflected in gross margin by the second quarter of this year.

With respect to the facility in Toulouse, France, we have been working now for several quarters with our customers to transition production to our 200-millimeter facilities in the U.S. Even now we continue to see demands from our auto customers for products produced in the Toulouse factory. We now expect production from the facility to be completed early into the third quarter.

We expect the gross margin benefit from the closure to begin in late 2012. At this point I’d like to turn the call back to Rich.

Rich Beyer

Thanks Alan. I’ll now spend a few minutes discussing some of our Q1 highlights. In the automotive market, one of the biggest opportunities for growth will be associated with the adoption of advanced electronic systems in vehicles developed for emerging markets. Simplifying the design implementation and reducing the building material cost are critical to success in each fast growth emerging markets. And Freescale is leading the way with innovative solutions that deliver significant cost savings.

Utilizing our S12 MagniV mixed-signal microcontroller portfolio, we introduced a single chip solution that will enable developers to create a comprehensive instrument cluster design with fewer components, reduced port size and improved quality. We also introduced an S12 MagniV single chip solution for brushless direct current motor control.

This is the industry’s most highly integrated solution for automotive HVAC blowers, wipers, fuel pumps and water pumps. And to help bring next generation technology to automobiles in China, we announced the partnership with First Automobile Works one of the leading automotive OEMs in China.

We established a joint automotive lab with FAW focusing on new technology R&D, powertrain control, active safety and new energy technologies. In networking we continue to leverage our leadership in embedded communications processing to deliver scalable multi-core solutions for data center and cloud based applications as well as next generation femto, pico, metro and macrocell wireless base stations.

We announced that Airvana and IP access have adopted QorIQ Qonverge technology for their small cell base station solutions. Companies adopting QorIQ Qonverge processors currently account for more than 50% of the small cell base station mark.

We also announced that our T4240 QorIQ AMP processor achieved the industry’s highest ever CoreMark performance score which benchmarks performance per watt and overall embedded processor performance. Our QorIQ AMP series targets the fast growing datacenter market for cloud computing.

In the industrial and medical markets we are seeing connected intelligence trend is transforming interactive terminals in a way that it’s driving explosive growth in machine to machine connectivity. In March Freescale introduced our new Vybrid Controller Solutions platform.

This is an innovative multiprocessing platform that integrates an ARM Cortex A applications for it and an ARM Cortex M microcontroller core on a single chip. That can simultaneously handle the high level operating system require for a human machine interface, connectivity and applications computing as well as the processing required for a safe and secure real-time functions.

A new Vybrid Controller Solutions combined with our Kinetis microcontrollers and i.MX applications processors give Freescale an unparalleled breadth of solutions based upon the ARM 32 bit architecture.

In the consumer market we are seeing a generation of applications that incorporate high resolution displays, touch screen interfaces and connectivity. Our i.MX 6 processor series has experienced strong acceptance across a broad range of applications including eReaders, IPTV, IP phones and personal medical monitoring systems. These smart mobile devices are also adding multiple sensors to enable applications like augmented reality, 3D gaming, eHealth and location-based services. At Mobile World Congress we introduced our new Xtrinsic eCompass Software that works with our Xtrinsic smart sensors to improve the user experience by delivering more accurate orientation data for these services.

All of you turn to our Q2 outlook. We expect Q2 revenues to be in the range of $975 million to $1.025 billion. On a sequential basis we currently expect that our automotive revenues will be up mid to high single digits, our networking revenues to be up mid single digits, our consumer revenues to be up mid to high single digits, our industrial revenues to be up mid to high single digits. The growth in our core businesses will be partly offset by a decline in our cellular business to more normal levels. And finally we expect gross margins to improve approximately 50 basis points sequentially.

Now let me make a few comments on the second press release we issued this afternoon about us launching a CEO succession process. When I joined Freescale in March of 2008 I committed to the Board, our team and my family that I would lead the company for at least four to five years and that I would ensure that we build a strong management team, a powerful growth strategy, an improved capital structure and strong prospects for the future.

I believe that we have made significant progress towards these goals and while Freescale has numerous opportunities for improvement, our company is on a healthy trajectory for success. So, I have discussed this with the Board, and the Board and I want an orderly plan for CEO succession. Therefore, we’ve started a process with the assistance of an Executive Recruitment Firm to find the next CEO of Freescale.

This search will consider both internal as well as external candidates. This process will likely take some time. During this period, I will continue to lead the company as aggressively as I have since I joined in 2008. Upon the appointment of the next CEO, I am prepared to serve the company in anyway the Board and the next CEO determined would be beneficial to the company.

With that, Alan and I would be happy to address your questions. Operator?

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). And our first question comes from John Pitzer with Credit Suisse. Your line is open.

John Pitzer – Credit Suisse

Yeah, good afternoon guys. I guess Rich just to the second press release of the afternoon. Just kind of curious any insights on the timing of your decision. And I guess more importantly, one of the key initiatives you have when you came on Board back in March of 2008 was to kind of rebuild some customer relations and the bridges there and kind of reinvigorate some R&D. And so when you look at the announcement that’s on the tape today. Can you talk a little bit about how you are going to kind of bridge customer confidence by the CEO search is going on and I have a follow-up. Thank you

Rich Beyer

Okay, John. The timing is based upon the fact that I believe the company is in very solid shape that we are at the beginning of the growth part of the industry cycle and our own cycle.

I think the things that we have accomplished and the fact that we have a very strong team provides the foundation for us starting a process for our new CEO. Such a process can take just a couple of months on the other hand they typically take significantly longer than that and I want to ensure that the new CEO takes over during the time when things are moving up in terms of the cycle.

On the second question about customer relationships, relationships with partners. When I joined it was significant part of my responsibility to re-establish confidence across a number of different markets. We did that initially, those customers were willing to give us a chance, but what has happened is that the execution of our team, the execution of our company has really been the foundation for re-establishing those strong opportunities. And my team now has nurtured those opportunities and we are all confident that the relationships that we have across these various markets will continue.

As I also said I will remain in this position driving the company as aggressively as I know how until such time as the new CEO takes over and during that period I will continue to maintain significant contact with those major customers.

Mitch Haws

appreciate that. And then just on the networking business can you just update us a little bit on the competitive landscape Broadcom now having absorbed the NetLogic acquisition. And I guess more importantly with Intel’s recent launch of Romley, they’ve talked about I think in north or upwards of 100 OEM design wins for Romley within the networking space. How do you see, just the competitive environment playing out as we start the beginning of this cyclical upturn?

Rich Beyer

Well, we saw – as Alan pointed out we saw that in the digital part of our networking business we actually grew this quarter that there were only a handful of data points as you know in the market about how the market is performing. But we think that growth represents a clear indication that we are doing well. Some of the systems on the enterprise side as well as some of the systems on the wireless side are growing and our business as a result is growing. Intel plays in certain parts of the market and we have no doubt that they’ll continue to be successful.

We haven’t seen dramatic changes in NetLogic as a result of the acquisition. We have no doubts there will be, but we haven’t seen any yet. So we think our strategy, our product families on the DSP side as well as the microprocessor side are very, very sound strategies and we think our growth in Q1 and the projections of continued growth in Q2 are indicative of the fact that we are holding our own slash actually are gaining in that market.

John Pitzer – Credit Suisse

And then Rich, my last question. RF has been an area of strength for several chip companies. I guess there is some growing concerns about maybe some supply disruptions away from the semiconductor food chain within the automotive vertical around some potential resin shortages. Have you seen anything to that effect or are you baking any of that potential into the guidance you’re giving for the June quarter and I guess could you remind us just your geographic distribution of your auto exposure because there is some sense that this might hit the European segment harder than maybe U.S. or rest of world?

Rich Beyer

We are aware of that potential disruption to the product manufacturers, we’ve discussed this with our Tier 1 customers and have not gotten any indication from them that they expect any interruption in the near term. So we do not believe it will have any impact on us certainly in Q2 we’ll obviously monitor the situation.

In terms of our geographic distribution we have the strongest participation in content in products made by North American suppliers. Next its – next is the European market and I indicated that it was part of what had an effect on us in Q1. Next is the Asian market China and so forth and finally in is Japan although as we’ve said in the previous several calls, we’re starting to gain some momentum in Japan as some structural change take place, so we think North America is doing great. Europe is problematic but the other market seem to be doing fine and that’s all embedded into the guidance that we just gave you.

John Pitzer – Credit Suisse

Perfect thank you very much.

Operator

Thank you. Our next question comes from Jim Covello with Goldman Sachs.

James Covello – Goldman Sachs

Great guys, thanks so much for taking the question. I appreciate it. I guess first question sometimes a difficult one to answer but in terms of the improvement that we’re seeing across the board in the various segments in the second quarter and the June quarter, how much that do you think is inventory restocking from the channel and inventory restocking from customers versus improvement in underlying end demand.

Rich Beyer

Jim we think most of it is underlying demands. We did talk about the fact that in automotive we had seen actually a little bit of overstocking and we think that’s now back to normal and we don’t see that as a result we don’t see the demand in that market is going up because of our customers building their inventory.

In networking we also believe there have been some quite lean quarters and as we look at what’s transpiring in the growth that we are seeing it’s pretty targeted pretty specific which customers and we can see why those customers are increasing their demand on us and again it doesn’t seem as any inventory builds.

And then as we indicated that distribution which obviously serves our industrial market we distribute our inventory of our product went down in the quarter, trends went down and we don’t see any evidence yet in the uptick, but that’s happening our Kinetis product family which began to rollout in production in Q4 continues to grow nicely for us and that’s part of the benefit we’re getting in industrial service. Our growth Jim appears to be based upon increasing demand.

James Covello – Goldman Sachs

That’s helpful. And if I could ask as my follow-up some sense of the slope of the order improvement as we went throughout the quarter in other words did we continue to accelerate growth in new orders exiting the quarter or did we kind of see a pickup at the beginning in the quarter and order stated a high level exiting the quarter, but the trajectory of that order growth flattened out a little bit?

Rich Beyer

Jim the orders in Q1 they were okay at the beginning of the quarter, we did see an improvement in the March timeframe and that improvement is continuing for the first several weeks of April.

James Covello – Goldman Sachs

Really helpful. Thank you so much.

Operator

And your next question comes from Ross Seymore with Deutsche Bank.

Ross Seymore – Deutsche Bank

Hi guys and first Rich best of luck in the retirement. Couple of margin questions for you, Alan can you walk through the 0.5 margin improvement, I am a little surprised that I wouldn’t be better given full quarter Sendai, and just the usual utilization and fixed cost coverage and then how that plays out through the year on all the applicable levers that you have?

Alan Campbell

Yeah I’d be happy to Ross. The approximate 50 basis point improvement we have given obviously we have confidence in achieving that. We have historically said that we can improve 50 to 75 basis points per quarter. What we are seeing in the second quarter is that if we are not seeing much uplift in the utilization, so embedded into the 50 basis points is usually zero associated with utilization.

We have as part of our strategy over the last three quarters made a decision to build on our work in process inventory, so that we could react quickly to this upturn in the market, which I think we are in a fortunate position though that we seeing the upturn and we can react quickly. So in the second quarter most of the increase will be associated with the building blocks that we talked about before of operational efficiency, procurement and I’ll let you bet on depreciation.

We are not seeing any kick on the utilization because of the inventory situation. As we look out into the second half of the year we do believe that will be accelerated because we will start to see the benefit of utilization coupled with those other elements I’ve talked about in operational efficiency procurement, depreciation et cetera. So we have guided the approximate 50 basis, but we see an acceleration in the second half as we get some of the benefit of our utilization.

Ross Seymore – Deutsche Bank

And is that utilization you talked about front end or back end that’s staying flat because I believe the back end in the last couple of quarters has created the bigger headwind to the cost structure?

Alan Campbell

In the second quarter our utilization is relatively flat for both front and backend, again we have – we have a lot of what can process in place. So we do anticipate our utilization to improve as we end the second quarter and going to third and fourth.

Ross Seymore – Deutsche Bank

And then as my follow-up question just moving over on to the OpEx side I think, how should we think about that for the second quarter and then what’s the plan on OpEx growth relative to revenue growth as we go into the second half?

Alan Campbell

Yeah so we have taken pricing, actions first of all to control OpEx in the first quarter. We do anticipate the OpEx will grow into the second quarter, driven really by a couple of items the first and foremost is the stock compensation. There will be an increase of approximately $4 million associated with the stock we did issue stock since the first time since the IPO to the employees of the company. And now we’ll have an additional quarterly expense of $4 million. On top of that, we also anticipate that we’ll try to buy from an expense associated with the R&D and there will be some, one-off type expenses associated, but there was a marketing conference we saw.

All that said we will and probably in the range of $15 million into the second quarter and we’ll try hold that candidly as we go forward into the second half. We do want to operate to the success model that we’ve communicated in the past of 11% of SG&A and 17% of R&D. So we still got that to go as a percentage of sales of R&D is higher and that’s been conscious decision obviously to focus and keep the R&D in place to ensure the longer-term growth in the margin expansion.

Ross Seymore – Deutsche Bank

Great, thank you.

Operator

Thank you. Our next question comes from Doug Freedman with RBC Capital Markets.

Doug Freedman – RBC Capital Markets

Hello this is Earle Heggie calling on behalf of Doug Freedman. Thanks for taking my call. It appears that most core end markets are ready to recover in Q2 looking beyond Q2 what is the state of the recovery in the com infrastructure space, what are some puts and takes there as you may assume currently?

Alan Campbell

We do expect a continued growth as a corporation in Q3 and Q4 we, the acceleration of backlog that we’ve seen to-date for Q3 supports that. We do think that networking is going to improve for us in the third and fourth quarter both in digital content and the RF. We believe the inventories of RF that we mentioned on the call will be backlog to our normal state by the end of Q2 and it will start to grow and we also envision at the digital parts for the com processors and DSPs will also grow in both third quarter and the fourth.

Doug Freedman – RBC Capital Markets

Okay, thank you. Then a quick follow-up as the fab consolidation efforts are largely complete you’re still roughly 10% away from the low end of your target margin range, what’s your biggest driver beyond the general macro recovery getting us there at this point in time? Thanks.

Alan Campbell

There are not when the – although that the closure of our Toulouse French facility will be at the early part of Q3 now. We do so have significant cost reduction opportunity and savings associated with our closure. It is communicated in the product side so that will be above 70 million of annualized cost savings which is probably one of the biggest in the gross margin improvement. On top of that again is the technical building blocks we talked about which is the utilization of our existing facilities. The operational efficiency the blocking and tackling the procurement plus the depreciation, so we’re still we believe we are still on the track to continue to enhance the gross margin.

Doug Freedman – RBC Capital Markets

Thank you.

Operator

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

Harlan Sur – JPMorgan

Good afternoon and thank you for taking my question which on the – I think enterprise networking was it relatively price powered for the team in the second half of last year how did that segment perform in Q1 and what are the trends you’ve seen here in the second quarter?

Rich Beyer

That group it was one of the drivers of the microprocessor the composite credit business and the sales did grow in the quarter and we’re seeing nice momentum it is also clearly expected to continue to grow in the second quarter and beyond.

Harlan Sur – JPMorgan

And then just staying within your networking segment with the guidance for growth in Q2 and maybe the potential for more growth beyond that could you just talk about the CapEx spending trends you’re seeing by geographic are you expecting may be the North American and European carriers to kind of start to spend first followed by the Asia guys.

Rich Beyer

Yeah we are seeing at the moment the North American guys are in fact showing signs of life and that clearly is helping we are well positioned with some of the major equipment suppliers in to the North American service provider market and we expect that to continue to grow. We are not counting on significant growth in Europe given that the macroeconomic environment, we’re not holding out a great expectation for growth there, we do think that we’ll see some continued modest growth in the second half of the year in China, we may be fortunate and maybe more robust, but we’re planning on modest growth.

Harlan Sur – JPMorgan

Great.

Rich Beyer

And we’re seeing okay growth in Japan and Korea for example.

Harlan Sur – JPMorgan

Great and then my final question how should we think about inventories this quarter, is the team going to continue to build inventories ahead of the Toulouse fab closure?

Rich Beyer

I’ll take that one if I can Alan. The answer is no. We did build inventory in the second quarter, which was predominantly associated with end of life product for the Toulouse facility. We recognize that we now have a poised up situation with our inventory and we expect our days of inventory to actually reduce as we go into the second quarter and beyond.

Harlan Sur – JPMorgan

Great. Thank you very much.

Operator

Thank you. Our next question comes from Stacy Rasgon with Sanford Bernstein.

Stacy Rasgon – Sanford Bernstein

Hi this is John Caskey for Stacy. I was just wondering if you looked at Q4 of ‘09 your revenue was about the same level as it is now, but this quarter your gross margin is about 450 basis points higher, if we look to you going back to 1150 or 1200 in revenue should we therefore be able to see an extra 450 or 500 basis points in structural margin improvement of your previous revenue pick?

Alan Campbell

Yeah John I’ll take that one. The answer again is yes to that. I think as I said earlier to one of the questions that one of the more significant improvements we are going to see is associated with utilization and we are not seeing that in the second quarter by choice with the inventory situation when we get into that 1200, 1250 range I think is very reasonable to expect that type of improvement in gross margin.

Stacy Rasgon – Sanford Bernstein

Is there any benchmark you could give us in terms of a five point change in utilization what that could do for gross margin?

Alan Campbell

There is actually be of – we historically gave this year that for every 1% improvement and utilization we would see about 30 basis points improvement in gross margin. As we go forward we actually closed down the facilities that will be slightly less but it still be in the 25 basis point, so that’s a good kind of indicator to model the gross margin improvement.

Stacy Rasgon – Sanford Bernstein

Great. Thank you.

Operator

And our last question comes from Jake Kemeny with Morgan Stanley.

Jake Kemeny – Morgan Stanley

Hi, congratulations Rich on your retirement. And Alan just a question for you on the cap structure, the balance sheet is still fairly levered, you still have a lot of absolute debt. Have you guys considered issuing equity to try to delever or are there any other means that you guys are considering besides this EBITDA growth to delever?

Alan Campbell

The answer is no, we haven’t considered the equity to delever. We have been as you all know doing a lot of transactions over the last couple of years and we continue to evaluate the economics of the market relative to the cap structure. The transaction that we just completed in the first quarter is indicative of what we have been doing in that, you will see there is $20 million a year of interest.

So annual interest charge will now be round about the $500 million and we’ll continue to look in that. We’ve also said that any excess cash will be used, predominantly if you don’t know date. So that’s a counterpart of the operating profit.

Unidentified Company Representative

Okay, operator. We’ll close at that, let me just make a few remarks. We are feeling as I think you can tell from this call a quite positive the backlog has improved, the trajectory of the backlog has improved and continues to improve as we outlined in the guidance or for the core markets are growing either mid or single digits or as high as up a single digits. So, we think we’re on a healthy trajectory, we think our leadership in our target markets is being reaffirmed by the growth that we are seeing. So we think we’re on a back on a healthy trajectory as it’s certainly looks like the industry is.

The final point, I’ll make is, we won’t be ready in the anytime soon. Actually intend to keep driving of the company working with its management team, our customers and the investment community are passioned about the company, I love the company and while other people in this company are doing and I intend to be as active and aggressive as I’ve always been and I will see you at upcoming conferences and look forward to those opportunities. Thanks very much for spending your time with us, operator that’s all.

Operator

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

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