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Freescale Semiconductor (NYSE:FSL)

Q4 2005 Earnings Conference Call

January 19th 2006, 5:00 PM.

Executives:

Mitch Haws, Vice President Investor Relations

Michel Mayer, Chairman and Chief Executive Officer

Alan Campbell, Chief Financial Officer

Analysts:

Tom Thornhill, UBS

Glen Yeung, Citigroup Investor Research

Joe Osha, Merrill Lynch

Doug Freedman, AmTech Research

Ross Seymore, Deutsche Bank

Randy Abrams, Credit Suisse

Jim Covello, Goldman Sachs

Sami Feroz (ph), JP Morgan

Ambrish Srivastava, Harris Nesbitt

Tim Lash, Third Point

Mark Alocrum (ph), the Benchmark Company

Shawn Slayton, SG Cowen

Operator

Good afternoon and welcome to Freescale Semiconductor’s 2005 Fourth Quarter and Yearend Results Conference Call. All participants will be able to listen-only until the question and answer session of today’s call. At that time, to ask a question, press “*” “1” and record your name when prompted. As a request of Freescale Semiconductor, this conference is being recorded. Should you have any objections, you may disconnect. I will now turn the conference to Mr. Mitch Haws, Vice President Investor Relations. Sir you may begin.

Mitch Haws, Vice President Investor Relations

Thank you, Sam (ph). Thank you and welcome to our fourth quarter and yearend 2005 conference call. With me today are Michel Mayer, our CEO and Alan Campbell, our Chief Financial Officer. Earnings release and financial statements we’re discussing today are available at the Investor Relations section on our website at freescale.com. The call is being webcast live at our site as well.

Today we will make certain forward-looking statements. These statements are based on our current expectations and assumptions and we cannot assure you that these expectations will be correct due to the inherent risks and uncertainties for actual results could differ materially. Please review our documents on file with the SEC for detailed discussion contained the factors that could cause our results differ from the statements we make today.

This presentation is being made on January 19, 2006. It includes some sensitive information as the company undertakes no obligation to correct or update any information presented on the call. Now during the, today’s call we may also reference some non-GAAP financial measures that we believe provide useful information about our performance, you may find on our website that were correct reconciliations. Also as noted in that release, we did make some amount of reclassifications to certain expense items, the details are attached with press release and also on our website and I’m happy after the call to answer any questions about the reclassifications. With that, I’ll turn the call over to Michel.

Michel Mayer, Chairman and Chief Executive Officer

Thank you, Mitch. Good afternoon welcome to our fourth quarter earnings call. Joining me as always is Alan Campbell, our CFO. Today, we’re going to talk about our continued solid progress at bench with respect to our finance performance and spend some time on dynamics of our markets and portfolios as we head into 2006. So, a few of the highlights of our results we’ve made purely significant progress toward our target model in both gross margin and operating margin and we’ve made that well ahead of our brand. In the Fourth quarter of last year, we did reach our gross margin model of 45% and our operating margins were 30.7%. Our net earnings for the year grew 352 million to 563 and our EPS at $1.33 is more than double, the prior year. We increased cash and investment balance by a further 650 million in the year, ending the year $3 billion. This level of performance is clearly attribute to the team and their ability to execute better however, I recognize, we recognize that we still have a long way to go to reach our full potential as a company and we are not satisfied with those results.

As mentioned, our gross margins are effectively at the level of the target model that we established at the time of the IPO. This was reached ahead of our plans and I hope it demonstrates our commitments to execution, I think we have established so far a good track record over the past year, with all execution and steady progress towards the model.

We, consistent with the fact that we are not content about level of margin, we’ve deployed much more aggressive goals internally and we are in the process of deploying more aggressive goals internally as we start this year. And we have already mobilized the team to execute these more aggressive plans. Given our current portfolio, we believe at this point that the business can support additional margin expansion or at least 200 or 300 basis points in the next 18 months. Obviously, with a lot of the benefits of the increased utilization and depreciation leverage behind us, the base of incremental improvement will be somewhat more challenging going forward.

And, in order to drive further improvements in operating performance, we have recently added 2 executives to compliment out manufacturing team. Chris Chi, formerly President for UMC in Europe, joined as Vice President of external manufacturing and Gulzar Mohd Ali, formerly with Intel, joins as Vice President of final manufacturing overseeing assembly and test operations.

Chris has started and operated both 200-mm and 300-mm fabs, and he was President of UMCi Limited and Gulzar has have numerous important positions at Intel during her career. So we think they’re going to help us. We might, as we make progress going forward, update our model further but at this point, we believe, pickup and used to be very importance to articulate our plans that we know we can meet.

We spent much of 2005 driving gross margin improvement. At the same time, we were also examining our portfolio and our re-trading between revenue growth and margin expansion. I will have to remind you that we made decisions during the year that we’ll research in revenue decline in certain areas. In the long run, I believe the portfolio is getting much stronger from a margin perspective. We divested our long core clock business in the third quarter of ’05. That was a 25 million annual business in our networking segment.

We also decided to exit lower margin analog business in printers and focus all resources of higher growth better margin business. Apple which represents around 3% of Freescale revenue, we’ve transitioned away this year. In fact, that transition has already started. Q4 2005 revenue for Apple was significantly lower than Q3. Now we expect the transition, we continue during the first quarter with little on the revenue starting in second quarter. When taken together, this represents $200 million to $250 million of lost revenue which as you know will impact, our overall work pace for 2006 and partially offset the progress that we are making with our growth initiatives.

With that being said, I am becoming more confident in our ability to go to top line in the back half of 2006 and into 2007. And this is based on the base and quality of design wins across the portfolio. Looking at opportunity across the segment, the competitiveness of our power management and our RX solutions, including RX EDGE is a significant growth driver. We are well-positioned to gain share of Motorola and in the merchant market with these products which will benefit us both later this year and into next year.

Stay tuned fro some news at 3G GSM. In addition, we expect 3G to ramp strongly in volume at some point during 2006; we continue to make progress with Tier 1 handset manufacturer has been using our technology. Our comprehensive matured chipset is significant competitive at that base price. A good indication of the collection in wireless is a credit to Q1 which looks to be much more favorable than the typically historical to the 92 that we have experience in the past.

Looking beyond handsets, our wireless business have a very exciting showing CES earlier month in Vegas, our multimedia applications processor and power management chip are powering the new Toshiba gigabeat S Series Video players, we are in fact gaining good caption with our i.MX applications processors. They are being designed into more and more high performance mobile entertainment devices and smart phones. This is another new growth area for us that is starting to yield reserves.

Techno, one of China’s leading consumer electronics manufacturers has introduced two portable media players, both powered i.MX. Axia and Timfo (ph) unveiled their first smart mode models utilizing i.MX and Royal takes advantage of their high-end graphics ability of i.MX for the portable AmeriGo GPS Navigator and some major GPS brands that we can’t mention here also using our technology. Within our emerging wireless portfolio Freescale’s use of UBs will power wideband silicon software is being integrated into consumer products from Belkin and Gefen. This must release first use of UB-enabled consumer products for the US market, is for their talent educated to be on the market in the first half this year within a few months.

Let me now turn to Transportation and Standard Products. We saw double digit growth in both our 16 and 32-bit microcontroller portfolios for the year. We have been focused, as I said repeatedly on growing the consumer portion of this business especially in analog and are very encouraged as well by the double-digit growth price achieved during 2005. And we are expecting the trend; we are expecting that trend to continue in 2006.

As you know, we are the #1 supplier in automotive and expect to continue to hold that position in 2006. The worldwide automotive market was healthy in ’05 driven by demand in China and North America. It’s interesting to know that the demand in China was served by minimum car companies including the Big Three. However the worldwide automotive for production continues to shift to Asian manufacturers, Japanese, Korean due to market share loss of the Big Three in North America. We continue to make further as winning business in the Asian markets, who are Tier 1 customers, while of course continuing to be committed to our North American customers. We also got used to expand our portfolio with the introduction of our intelligence distributed console devices that combine our smart mode power management, with 8-bit flash microcontrollers and local interconnect networking. These dramatic reviews, is component count on wiring, in wending machines, poise of sales terminal and variety of power assisted automotive applications. You will see more and more SoC and military function applications coming out of Freescale as we increasingly leverage the incredible breadth and size of our portfolio to come together with integrated solutions.

Demand in automotive and consumer is strengthening and we are at a point where we are chasing supplies. We expect the TSPG business to grow in the first quarter but the extent of that growth will depend on how much valuables we shift.

In networking, based on our checks and demand we expect to see a recovery in our infrastructure business. However, we expect that goals to be more evenly distributed throughout the year, then in the prior, in the prior 2 years ’04 and ’05. As I said earlier, we expect the Apple transition to continue into first quarter, given the growth that we are seeing in other markets, we believe the new business can largely offset the loss of the Apple business, as it occurs.

We remain fully committed to the PowerPC architecture and during the past year those process have gained the increased popularity in the home-networking, consumer electronics markets, wining designs in applications such as voice-enabled VPN routers, residential gateways, home media serves, IPTV set top boxes and network storage, of course IBM is a 100% market share in gaming, also a lot of progress in printing and imaging and wireless in Transceiver base station and wireless LAN access points. You will hear more from us and partners on topic initiatives.

In the fourth quarter, I will make our corporation announce the store center network hard drive, a fast complete solution for storing, enhancing, experiencing ensuring all kinds of digital components on a home or small business network, based on PowerQUICC II processor. This processor provides more than enough power to support sending files directly to PCs and network attached entertainment devices.

I want to highlight the fact that the pace of design wins in networking has been a especially encouraging in the enterprise base, in 2005. With major enterprise networking companies and we expect these wins to contribute to other new significance towards the end of 2006 as well. To sum things up, we deliver them all gross margin commitment ahead of plan, we expect continued progress on margin in 2006, where we deliver our Q2 to 300 points basis points of improvement over the next 18 months. We are beginning to see the early benefits of our focus on accelerating growth.

We expect to close the GAAP versus industry sale growth rate starting in 2007. Given the anticipated of the rational improvements, we expect to achieve the high-end of the range of analyst estimates for EPS in 2006, which is at 30% to 35% growth rate from $1.33, before taking option expensing into account. Thank you for your attention and having said that, I would like to turn the call over to our Chief financial officer Mr. Campbell.

Alan Campbell, Chief Financial Officer

Well thank you Michel. As our results show, we have made solid progress in 2005 driving financial improvement. As a team, we are pleased with the progress as Michel officially if he’s relating, he’s at a still leads for continuous improvement. Michel also noted we have some small line item changes at a minor impact on our operating expenses and margins in each of our segments. There was however low impact to net income or EPS, and we will be happy to answer question on any of those issues after today’s call.

Let me now turn to the business. Our fourth quarter revenues were 1.48 billion; this represents a 4% increase from the same period last year, and a slight sequential increase. Autos for the fourth quarter were 1.5 billion representing a 1.01 book-to-bill, for the year, our sales ending at $5.84 billion. As Michel mentioned, also our continued focus on elements of gross margin resulted in the rush reaching our target model this quarter. Margins for the quarter were 45%, including some reclassification of 960 basis points from last year and also up 210 basis points from last quarter. We continued to realize benefits from operating efficiencies, continued across cost controls and factory utilizations. And net income was $192 million or 15% of sales. This performance compares favorably to the same period year, and the sub quarter level 164 million.

Let me now discuss some of the operating expenses which were 465 million again under the re-class method. The bulk of the line item re-classes was to reflect in cents of course to the appropriate line items and the income statement. Most of this represented a change from SG&A to R&D and Cost of Goods Sold. For SG&A was off on a sequential and year-on-year basis, driven by a higher level of spend on granting and an increase on incentives paid prior to our operating performance. But R&D was lower sequentially due to a higher rate of grant to typically occur in the fourth quarter. Our net interest income in the fourth quarter was $9 million compared to $5 million experienced a year ago and $1 million income this quarter. Again, this was driven by higher returns on our cash balance. Our operating margin for the fourth quarter was 15.7%, the highest level since 1995.

Depreciation and amortization represented 10.7% of sales compared to 15.4 a year ago and 11.4 last quarter. Our EPS was $0.45 per share, EPS a year ago was 1 penny or $0.18 excluding restructuring and separation cost. In the fourth quarter, we began to execute on the share repurchase program and bought back 4 million shares for $103 million. The exhibited, muted the impact of option dilution, and the fully diluted shares trend is 429 million.

Our effective tax rate for the full year was 18%, with a cash tax rate of approximately half of that. Now I will summarize some of the performance within this segment, I intent to report the segments including the reclassifications. As discussed, the impact is minor and the summary of the changes has included in the earnings release. The transportation segment in terms of product segment reported fourth quarter revenues of 649 million. This of course is 672 million before re-class, which is up 5% sequentially. Compared to the same period last year, we had a growth rate of 5%, as Michel said; it was driven by growth in Asia and Japan. But a particular strength across 16 and 32-bit microcontrollers as well as our strength is product. Our operating margin in the fourth quarter was 18%, excluding the impact of Delphi operating margins were 17%, this compares favorably to the 8.7 reported the same time last year, and 11.8% in the last quarter. Once again, key drivers of improvement of factory utilization and operation efficiencies. On a year-on-year basis, operating margins were 14.1% again comparing favorably to last year of 10.5%.

Our networking and computing system revenues was 358 million representing a 6% decrease sequentially. This was driven by softness in the infrastructure spending, but was costly outset sequential data performance in the enterprise market. On the full year basis our revenues declined 2%. Our operating margin again was very strong. Fourth quarter was 21.6% compared to 10.9% last year and 19% in the last quarter. For the full year the operating margins were 19.9% up from the 2004 level of 18.7%. The last business segment of wireless revenues, in the fourth quarter were 476 million or 453 million up prior to re-class, which is up 5%, continuing the change we saw in Q3. We continue to see strong units in 3Cs off by, offset by typical price of these 3Cs. Fourth quarter margins were 8%, again this compares to 7.5% a year ago and 7.7% last quarter. For the year operating margins were 4.4% compared to our loss of 5.7% last year. That concludes the discussion on the segment. Now we are going to take a quick look at the balance sheet.

Cash for short term investments in marketable securities, at the end of the fourth quarter was $3 billion, which gives us another of 143 million from the end of last quarter. Our domain results include 103 million for the repurchase of stock. Our capital expenditures were 147 million in the quarter or 491 million for the year representing 8.4% of sale. We continue to be very focused and make good progress on improving working capital. Our previous eatables and favor base in the quarter were 52 days and 62 days respectively. And this compares to 55 and 47 days in the sub-quarter. Inventories increased slightly by $10 million following a $105 million reduction since the beginning of 2005. Inventory days were 71 compared to the 69 days in the last quarter. Distribution inventories were down slightly and weeks of sales drop to below 10 weeks. This level has remained consistent for the past 8 quarters.

Now looking ahead into the first quarter of 2006, we expect revenues to be in the range of $1.435 billion to $1.535 billion. We expect gross margins to increase slightly from the operational level of 14 in the fourth quarter. Expiring the impact of Delphi and expiring the impact of stock option expense. During the first quarter of 2006 we will begin the expense, expensing stock options in accordance with FAS 123, to expect expense associating with this to be approximately $0.04 per share in the first quarter. This will impact the line items by approximately 4 million in gross margin and remainder spread evenly across R&D and SG&A. That concludes the remark today and I will happy to turn it over to the operator and open it for questions.

Question-and-Answer Session

Operator

Thank you. We will now begin the question and answer session. If you would like to ask a question please press “*” “1” and record your first and last name. To withdraw your question you may press “*” “2”. Once again if you would like to ask a question please press “*” “1” and record your first and last name. One moment for our first question.

Our first question comes from Tom Thornhill of UBS. You may ask your question.

Q - Tom Thornhill

I’d like to focus my question on gross margins. First part, when you talk about gross margin being up slightly from the operational level as in ‘05 and as in operating expenses. Is that 45.4 or 45 could you speak clear about that point please.

A - Alan Campbell

Yes, Tom let me try and state that one. The operational, the gross margins on the, the historical method that you are; that you are used to, it was 45.4, a significant achievement by the whole team. With some of the re-class that was reduced to 45. If you then exclude Delphi or the reverse that we took is approximately half a point. So, what we are saying is from the 44.5 we expect some operational improvement.

A - Michel Mayer

But, I’d like to just join in here, it’s an improvement no matter which one, what we are guiding is an improvement, if you had kept the old reporting to us. You would see sequential improvement from the 45.4 level neither than 5 minus reductions; if you’re taking the new re-class, you’re going to see closing come back so. You know that one, it doesn’t matter which one you, you choose. You’re going to see incremental improvement, do I make sense?

Q - Tom Thornhill

Yes, I am just trying to clear all that exactly which base to start from?

A - Michel Mayer

Okay well, going forward ask us, because we are starting Q1 ‘06 we do reclassify. We, our gross margin went down to 45% in Q1 from 45.4. So we are going forward studying Q1 ‘06, it’s going to be 0.4%, we know where we were during 2005.

Q - Tom Thornhill

Okay, and then your comment about the goal of increasing the margin target for the range by 2 to 300 basis points over the next 18 months. You’re referring to gross margins I assume, is that correct?

A - Michel Mayer

Yes it is.

Q - Tom Thornhill

And would you expect a steady increase before, how would you look at the linearity of that increase across time?

A - Michel Mayer

Allan.

A - Alan Campbell

Yeah, I think what we see Tom is that when you look out our performance over the last 18 months, that was steady as she goes and I would suggest that, it certainly going to get tougher as we go forward, as utilization rates and depreciation is not, are not going to be as significant or portion of the improvement. Although there has been significant efforts put in place on mobilizing the internal things to really focus on continued improvement while we, we will be formulating more detailed plans in communicating, but that’s steady as she goes.

Q - Tom Thornhill

So, for modeling purposes use sort of a linear trend.

A - Alan Campbell

I think that’s reasonable. Yes.

Q - Tom Thornhill

Okay, good, excellent performance.

A - Alan Campbell

Thank you, Tom.

A - Michel Mayer

Thank you.

A - Alan Campbell

Thank you, Tom.

Operator

Thank you. Our next question comes from Glen Yeung of Citigroup Investor Research. You may ask your question.

Q - Glen Yeung

Thank you. Michel your implied EPS guidance for the year, is somewhere between 122,123 and 129 and 180, recognizing that you’re talking the higher gross margin. Can you just try to give us a sense of how much of, the incremental EPS coming from revenue growth versus margin growth?

A - Alan Campbell

Well as, as you know in, I mean, the net of our view of ’06 at this point, I mean we, we, of course, we don’t, Glen, much share what’s going to happen in the overall economy in the second half of the year and I am sure that we, what we have the net of our view for ’06 is that we expect to roughly go within this free end and then loose that $200 million to $250 million that I talked about. And therefore as a result of that, goal, well the half of the rate of the industry, that’s the model that, lot of you guys have out there on that and of course, we hope to beat it, but at this moment so, were it’s a, it’s a reasonable, it’s the reasonable model. So, so when you look at where we are and we with some gross margin improvement into 2006, we are at this point, reasonable with the high end of the, of the earnings and in part of this is coming from, it can be pricing, we are releasing at $0.45 a quarter, right? So you do the math and, and you look at that. So we expect some pressure on the ASP that it will be about, so that’s why we are saying. So, so, what I am trying to say is that if, if gross margin in a sense that we have achieved our model earlier and therefore as we enter the year, we’ve had a higher level than it was for we previously modeled that gives us comfort that we can deliver the high end of the range.

Q - Glen Yeung

Campbell you’ve, when you are talking about raising your gross margin guidance, you’ve said, that you wouldn’t do it unless you failed, pretty much 100% helpful that you could deliver that in, in someday reasonable timeframe. See, I am really assume if that’s sure about the guidance that you’ve given us and also you can give us examples of, what we contribute to that hopefully?

A - Alan Campbell

Well.

A - Michel Mayer

Go ahead, I don’t have the numbers.

A - Alan Campbell

Okay Glen, first of all from a Scotsman nothing is 100%. So, let’s be very clear there. But we do believe that it is important to execute and did what we said we were going to do and, I think we do have some history there. Most of the, the enhancement in margin opportunity will come from the operational efficiency state of decreasing which is, as we’ve said before it includes a number of different things improving yields, looking at the portfolio of RF ICs continued supply chain focus. And there will be a small amount associated with depreciation towards the second half of next year; this depreciation will continue to fall off.

A - Michel Mayer

Let me evaluate to follow Glenn, because, I think I trying to assume your question. Our, the bulk of our focus in the first 18 months on gross margin improvement came from foreign bank from silicon wafers. And we are getting closer, we still have a little bit of improvement I mean, we’ve made a lot of progress, we can still, we are not benchmark yet on that yield, well we are becoming much better, but we still know that we have some improvement on yield and we can see that and as you know, that the material cycles with the fab and takes time. So that, those type of things you can pretty much predict what’s coming in front of you with a bit more confidence. But a lot of the improvements need to be done in GSM, and test backend, and we, as well as total yield at the guide level. We know that we have progress to make, which is good news, because we’ve identified those. So, that’s another area where you are going to see and that’s why I was highlighting the horse power that we are adding to the, to the manufacturing team here, to help get us to the next level, but we’ve benchmarked, we’ve done a lot of work with consultants and started the distinct cycle approached, we’ve used for a quantum size, we are in the process of applying, so further applications and also to supply chain level, we know we have some improvements. So, one of those depreciations of course as well, we have felt that depreciation coming in second half of ’06. I think and…

A - Alan Campbell

It was a helpful point.

A - Michel Mayer

Helpful point. So those things, does that help you Glen?

Q - Glen Yeung

All right thank you very much.

A - Alan Campbell

All right.

Operator

Thank you our next question comes from Joe Osha of Merrill Lynch. You may ask your question.

Q - Joe Osha

Good afternoon, congratulations on the improved performance.

A - Michel Mayer

Thank you Joe.

Q - Joe Osha

I want to drill down on the wireless business; we’ve been fearing for sometime that, now you might be able to show some, some activity outside of your, your major customer on. Can you give me some additional color there in terms of potential timing, or at least what you hope so. I know you can’t bring out your customers, but at least give me some senses to what we might look for. Thank you.

A - Alan Campbell

Well, we should, we knew that we are going to start shipping some significant things in the first half of ’06, let me say first half of ’06, to be a little bit competitive here. I don’t want to preview when you will get the visibility, Joe has got some of it, you’ll get visibility for announcements, some of which will probably get the visibility for Tier 1 website, when people choose not to announce with that and that’s particularly to for components, like, if we were to doing significant RX EDGE, which is an area where we think we are strong. I am not sure I mean, some of it will be announced some of it will not. But I think, by the time we reach 3G GSM in a few weeks, they will start to be some visibility of our progress. Then in ’06, we will, you’ll see more of the base band. The base band side, the platform side, it’s the thing that’s the longest pole right in the current, that’s the one that takes the longest time to off the vision engagement from when to bring you, or ready to shift. So that, you are going to see an end and there is also going to be some evidence as we go in the year that our wireless revenue is willing to go.

Q - Joe Osha

Okay, great. I am sorry, I got, I thought I had, I thought it out in your last comments so, I guess but, when I heard you talk about shipping some 3G revenue outside of your major customer, I guess the implication there when I were asking you about is the digital base scan business there. Are you saying you are going to ship digital base band in the first half or something else?

A - Alan Campbell

No in the first half we are going to ship all the thing, I again, I enjoy, I am trying to QC, I really don’t want to, I want to continue to be on the conservative side because we have phones that are getting ready here, but this is an industry where as you know very well that until people stop shipping their phones and some of those handset manufacturers, make those achievements, pretty late in their design cycle. Well, I repeat what I’ve been saying last quarter; we have 100s of engineers engaged with this Tier 1 handset manufacturer. We are making good progress, but then every time closer to the shipment base, I expect in the first half to have final decisions of shipments, I don’t confirm when those shipments happen from customers. But we are getting closer.

Q - Joe Osha

That’s fine I am not trying to humiliate down to too much detail. And my other question is simply looking at the gross margin, if I look at the extents to which, you have dropped, unprofitable businesses and your refocusing, the revenue that you have, I get to your guidance really almost just organically without assuming anything else. Is that basically what’s going on here, and you’ve liked yourself more room or am I wrong and is this, does this target must be given also encompass the operational improvements that you talked about?

A - Michel Mayer

Yes we liked to meet target that we would used to.

Q - Joe Osha

In other words…

A - Alan Campbell

I think Joe, is the combination, you got, we executing a part of just Joe I’m sorry, we’re executing a path in 2005 to look at portfolio. And we will continue to aggressively ensure that we do have the portfolio and that portfolio makes money. We’ve talked about penetrating and pushing more of distribution, discount of our new products, or trade view margins. But at the same time, there is not enough one, one leg it’s still, I think it’s very important to focus on the resonance supply chain on the yield, and it will be all of us again that would contribute improvement.

A - Michel Mayer

We clearly, I mean, believe some at the amount of, I don’t want if it comes out of given, but so many amount of digital room for pension in our guidance, but as we said we, I really believed it is extremely important and than when we do usual guidance, we made it no, couldn’t quote, no matter what happens in the industry conditions.

Q - Joe Osha

Sure guys. That’s entirely reasonable. So I…

A - Michel Mayer

And I do not, I mean do not have good visibility in the second half of the fiscal quarter.

Q - Joe Osha

Thank you very much.

A - Michel Mayer

Okay.

Operator

Our next question comes from Doug Freedman of AmTech Research. You may ask your question.

Q - Doug Freedman

Good afternoon guys.

A - Michel Mayer

Thanks for calling.

A - Alan Campbell

Good afternoon Doug

Q - Doug Freedman

If we could Alan, did you offer any guidance from the tax rate for the first quarter and the full year for ’06?

A - Alan Campbell

Yeah, I think Doug, it, I think it fair to, for modeling purpose, is to continue at 8% tax, as we enter for 2006. Always those are going to be a function of profitability between the domestic and international. But for modeling I think it’s safe to say that 8% is reasonable at this point.

Q - Doug Freedman

And that’s for the full year?

A - Alan Campbell

Yes.

Q - Doug Freedman

And then Michel would it be possible for you to give us some idea of sort of the wireless growth that you are expecting in the area, I know you don’t want to disclose customers, but maybe if you would give us some idea of growth that you might expect to see from the wireless segment that might help us understand this is what magnitude success you are planning on?

A - Michel Mayer

Yeah, well you know seats we expect, rules that, I mean, it really should accelerate in the second half of ’06. So, we haven’t been guiding followed by segments. We expect to obey share clearly, we unless it has become thinking so why you want to stop guiding on router, then I don’t think I didn’t. So, I am going to say, we’re fit to go year-over-year, we, I need to add a little bit more visibility on the two things like the success of my customers with the model that we introduce, because, this is not existing business, that I have a good handle on, and so I don’t want to be speculating on those type of, and that’s part of question, because I have a good seem for the most all recognitions obviously, and I have the historical data that allows me to judge, I am entering into periphery area I do not have a country, so its going to go grow, but it’s a little bit too early to stay back by how much.

Q - Doug Freedman

Okay. If I could, two just, two more questions on sort of house keeping, percentage of sales that we’re going through distribution and then the percentage of wafer supply that was from external sources?

A - Michel Mayer

Yeah distribution revenues as a percent of the total deal were relatively flat from last quarter and it’s fair 15% range and the outsourcing that we did also I think was relatively flat, is 17% was the volume of silicon that we outsource.

Q - Doug Freedman

Terrific thanks guys, fabulous results, thanks again.

A - Michel Mayer

Thank you, thank you very much.

Operator

Our next question comes from Ross Seymore of Deutsche Bank. You may ask your question.

Q - Ross Seymore

Thanks, and I got those, congratulations. Just a question on the operating margin in the Transportation Good showed a nice pop, even if you scrub it down as the Delphi, what sort of incremental improvements could we see going forward from that level? And if I recall correctly, a year above what your target operating margin was in that group. And should we be thinking about a new benchmark?

A - Michel Mayer

Thanks Ross first of all, it was just an outstanding performance within the program and at least our Transportation that have grip, literally that had on all selling those in this quarter within the grip, for you know we were fortunate with the utilization of our five seats we had some Delphi dealings and there was a lot well operational efficiencies with, as well as the portfolio. So, that’s hit on all cylinders. We, when are we going to get guidance obviously but we are re-looking at raising the bar across all three segments, and I think you’ll hear more to come in that one. So of late, a light it deflect or let go at this point on German’s specific on opportunities, they did exceed expectations even after adjusting for Delphi. So, full credits on our full team.

Q - Ross Seymore

And then a couple of more house keeping related ones, on the orders, you gave the total orders, I believe in prior quarters, you’ve given them by segment, can we get that again in this quarter please?

A - Michel Mayer

Yeah, I think the order rate for our Transportation, it was just over 1, I think it was at 1.03 our networking was stronger of 1.06 and our wireless was just a low 1.97.

Q - Ross Seymore

Okay then the final question somewhere to the prior 1, on the utilization side I think what was your internal fab utilization in the quarter please?

A - Michel Mayer

Again, that’s 3, I don’t think about disclosing specific utilization but, utilization nor said continued to improve for almost first quarter raise into the fourth quarter.

Q - Ross Seymore

If I recall right that would put you somewhere in the very high 80s or low 90s. Is there a level at which you really have to start investing more capital or it is growth pickup, any sort incremental capacity need that you, that may arise over the course of the year?

A - Michel Mayer

Yeah I think first of all, that is the level of revenue, while looking at the whole capital expenditure is, this week we spend, as we said 8.4% of sales and 2005 and up our model has said that we’re late to the accumulates of the 10%. So we are looking at the whole the capacity situation, and we will be looking to make things sure, as much as we can, that’s we are selling in towards capacity bottle makes are becoming half.

Q - Ross Seymore

Great, thanks and congrats again.

Operator

Our next question comes from Randy Abrams of Credit Suisse. You may ask your question.

Q - Randy Abrams

I am just, good afternoon guys, I am here to get one follow up on the last point. And if you could just talk about 2006, what your guidance for capital spending will be?

A - Michel Mayer

Well again we don’t give guidance specifically Randy for CapEx, but we can tell you that we’ll continue to be flexible through the market, and we are going to open it with in the cumulative 10% percent levels. So if we continue to see the solid performance that we’ve seen in 2005, and going into ’06. We will, we could spend slightly even more than the 10%. But we are keeping to the model of that cumulative 10% model.

Q - Randy Abrams

Okay, in the middle looking at your networking business, it looks like the enterprise side performed a little bit better than the carrier side. Could you talk about what you are seeing with trends, I think you, how it differs from big design wins coming, maybe just talk about the products and the opportunity you have on the enterprise side of networking.

A - Michel Mayer

I’ll leave that to Alan so, for this the networking; but by the way I, networking result, I am sure you guys have picked up at my comments about how offer revenue was eventually lower in Q4 then it was in Q3. And the Delphi wasn’t conceding it again and so that’s something also you have to do such earnings to judge the health of the networking business. What we, what have happened in 2005, I understand what your question is, recently significant over us in designing profit share into wireless and switches, with using enterprise networking company. And so that’s what’s behind my comments, as those product are but in starting in the end of the 3 kind of 7 and we expect a significant improvement. Do you also hold until we expect what I was trying to communicate, what we, if we look at our pipeline to design wins, we know we are positioned to stop gaining shares, at least you can see the relieve on near the end of, in the second half of season then going forward. Short-term, we are seeing some, we are seeing some strengthening, but I mean not gaining to be, the overall market, I mean there is nothing to be worried about us.

Q - Randy Abrams

Okay fair enough, and then just lastly on the R&D expense I think you’ve heard about the credits that went down sequentially. And when we look at the first quarter should we use third quarter run rates of what to move ahead from and maybe talk again about SG&A kind of what your expectations are over next couple of quarters for growth in SG&A.

A - Michel Mayer

Yeah, well we to suggest them on the, its somewhat confuses, some of the reclassifications and to simplify is probably easier to keep it relatively flat from the fourth quarter levels. So keep operating expense and total reasonably flat.

Q - Randy Abrams

Okay thanks a lot guys.

A - Michel Mayer

Okay thank you Randy.

Operator

Thank you. Our next question comes from Yuko Miyake (ph) of Goldman Sachs. You may ask your question

Q - Jim Covello

Hi actually it’s Jim Covello. But, first of all, congratulations on the continued great execution. Secondly, your big wireless customer tonight on their conference call were suggesting that they were short of some components not so I can, but I guess some other custom mechanical component. And that prevented them from shipping a little bit more and they may could have been in the fourth quarter. Do you have any thoughts on how that might have impacted you business in Q4 and how it might impact your business in Q1?

A - Michel Mayer

Well I don’t, Jim, good evening before but, as you, as you know we, we shared the word a little bit from guiding on more on our customers in general and somewhat all are in particular with that being said we, we probably could have shift I think we you are right, if only could we have shipped a little bit more, silicon to them so, so I think we could, on the revenue we, we do not, we do not expect Q1, I mean Q1 I think they might, because of all that and anyway we entirely say, yes, it could have, let me be, it could have shipped more including Q4 and Q1 we are guiding quarter-to-quarter.

Q - Jim Covello

Fair enough, I think I, think I understand that. Next question said on the margin improvement and particularly relative to the utilization, how important is continued very high utilization levels to this continued margin improvement, in other words is there any slack in, in the margin improvement goals though that if you were to see any down picking utilization that you could still see the improvement in margin over the next, 6 or 9 or 18 months.

A - Alan Campbell

Yeah that is high Jim.

Q - Jim Covello

How?

A - Alan Campbell

Utilization rate first of all I would suggest that there won’t be as much leverage of the continued improvement as the result of utilization of our factories. Obviously the market conditions fluctuate well more and one of the things that we pride our self and this is the kind of the flex, the flexibility that we have between the different relationships and partnerships internal to external, but we didn’t anticipate the major fluctuations and margins as a result of utilization mix been done.

A - Michel Mayer

One of the thing that may have the apparent from the, from an external view is that we’ve spend a lot of time in mid, since mid 2004, really improving our supply chain end-to-end and part of it was sourcing capability driver-sourcing and really making the flex model work and so part of the high utilization granted is the result of a market condition, but frankly more and more of it is the result of the, a better supply chain which allows us to, to flex in and out better and therefore if you want to maintain high organization going forward against the, remember we, we do use 17% of the external foundry and, and I think 50% of external assembly and test, so I think we are more sophisticated in our, in our model now of course. We, we won’t read about any, complete collapse of the industry and you might, we all understand that right.

Q - Jim Covello

Sure that’s terrific, that’s very helpful. I appreciate the explanation and congratulations again.

A - Alan Campbell

Thank you.

Operator

Thank you. Our next question comes from Chris Danely of JP Morgan. You may ask your question.

Q - Sami Feroz

Thanks and this is Sami Feroz (ph) for Chris Danely. Question on what would be in the scenario typical Q1 seasonality given, the reclassification that have been going on and, and you know some of the end-markets now, changing it all in terms of outlook?

A - Alan Campbell

Yeah, it seem outlooks, I would suggest first of the reclassifications one impact anything on seasonality from our, our revenue standpoint we historically see seasonality in the first quarter being down slightly from now in the fourth quarter. When those seeing that typical seasonality at this point, but we are seeing a little bit change across the businesses, for it anticipate typical seasonality as we enter into the first quarter.

Q - Sami Feroz

And then a follow up on Disty selling was to sell through, could you comment on what were the rates in the fourth quarter and any of your expectations for the first quarter and then I have one follow up please?

A - Alan Campbell

For, Disty that as we’ve said before that we, we recognized revenue in our sale-on basis, we show very good controls on mechanisms in place to monitor, what the re-sales are as well as the inventories and as we are speculated on the call, the inventories are actually continuing to decline so we feel very comfortable in terms of guiding for Disty going follow up, so I’m not sure I want to do that risk point. But, from a control mechanism we do that sale-on basis.

Q - Sami Feroz

Great and then one final question is on pricing trends. Could you comment on what do you see as the general pricing pressures in some of the end-markets?

A - Alan Campbell

Yeah the, the pricing trends are always going to be they’re a function of markets as well as volumes. As we’ve said before on our three business segments are, our wireless business is more exposed to much heavier pricing than the role of two businesses, again we have, as we’ve seen in our wireless business seeing significant unit growth and that has been offset by, maybe typical but very aggressive pricing. You don’t see the same in our transportation but the all businesses are on the pricing pressure, the key issue is to, as you go on last, introduce the new products with additional volumes and try optimize on those basis.

Q - Sami Feroz

Okay, great thank you.

A - Michel Mayer

Thank you.

Operator

Thank you. Our next question comes from Ambrish Srivastava of Harris Nesbitt. You may ask your question.

Q - Ambrish Srivastava

Hi guys and congratulations on very solid conclusion here. Two quick questions, one is the guidance for depreciation for ’06?

A - Alan Campbell

I think Ambrish hi, I think we said that the depreciation in the quarter was 10.8% and we have given guidance to get to 10%. You should see some improvement in depreciation primarily focus in the second half of the year to the churn of half a point.

Q - Ambrish Srivastava

Okay thanks. A couple of questions for you Michel, if, if you look at the comments, I think you have made on the, accelerating growth in the back half of the year, which segments or step segments do you expect to drive that and then on the wireless front, I guess you have addressed some of it. If you look at the largest customer unit growth, they are 3% to 40% year-over-year and when you look at your growth essentially flat, how much of that, is a typical pricing and it sounds like it’s a little bit more than typical. Do you expect that to abate or do you only hope for that abating is getting customers outside if you’re going to out customers?. Thanks.

A - Michel Mayer

Yes the two questions, so, so the 34% from that role out is according is this to revenue or unit, I think its unit right?

Q - Ambrish Srivastava

Yeah.

A - Michel Mayer

Okay that’s unit. So our unit growth in wireless, I mean I don’t think we’ve disclosed it we can disclose it, is what I thought of fair, it’s that 20, I think the wireless is roughly 25%. So, half is you want, half of the role of, of and I’m sorry, you want to pretty assume. So did, did some of net value is that, with what has been growing in the low end, a little bit faster in particular, when this source operator side and, that using OEMs which I’ll let make setting using off sheet, so you cannot make a one for one comparative between not all unit shipments and off shipments. So, but you are right. Although we have increased, around 30% of something in term of volume year-over-year, our revenue is seen of various improvements and you can derive from that, a reduction that we have, we have delivered. Part of it, is because we, we have to become more competitive. I think, year-over-year from our falling position and so you could say that this professional demand of our, with production improvement in that segment has been stuck in terms of if the reduction and the second thing is that there, there has been normal I mean there has been higher pressures in ’05 on chipsets, ASPs compared to phones because of the slow rank of 3G and so, so what you seen, you’ve seen a, a longer cycle if you want that 2G phones and 2.5G phones with the normal curve of reduction and not at this point yet, we, -- if you want from the next generation, that’s really because typical some decreases generation where you look 1, 1.5 to 2 to 2.5, the page which you want for replacement of, of the quick and quick, all that technology by the newer was a little bit faster and therefore was the pricing in industry is then along those lines with 2.5G chipset continuing to go down aggressively. So, you have all of those things. Now going forward I think I know we’ll fight very competitively, we expect 3G to finally faster on that, in 2006 and so I do not expect that same aggressive trend to continue into ’06.

Q - Ambrish Srivastava

Okay, thanks Michel, I appreciate the calendar and the other question was on the growth in the second half of the year, which segment you expect to drive that.

A - Michel Mayer

Sorry, I am sorry Ambrish.

Q - Ambrish Srivastava

Well as it is ...

A - Michel Mayer

but the one that we’ve been highlighting since into 2 quarters which is consumer in planning and in analog business and consumer electronics power management, i.MX and so the whole consumer electronics initiative, our RX business in wireless we expect to be kept and networking enterprise business.

Q - Ambrish Srivastava

Okay, thank you very much.

A - Michel Mayer

Alright Ambrish thank you.

Operator

Thank you. Our next question comes from Tim Lash of Third Point. You may ask your question.

Q - Tim Lash

Hi congratulations on, on the margin improvements.

A - Michel Mayer

Thank you.

Q - Tim Lash

Quickly, you, and in your press release you referenced manufacturing ownership realignment and cost allocations and product allocations between the segments, that seems to have you uncovered them, some very healthy increases in profitability of TSPG, given this sort of refocus on who owns, what in terms of manufacturing and where products belong and how cost are allocated. Do you have any thoughts as to, where TSPG is sits in the longer term structure of the organization it seems as though you crystallized the profitability there, are there opportunities perhaps to consider, consider strategic alternatives for that unit.

A - Alan Campbell

First, Tim thanks for your question. First of all let me tell you just, that more collateral into, what happened and what’s been happening. The historical method was that the business segments actually owned the factories over the landlord of those factories many under utilization of cost where it picked up. As the factories have got fuller and there is so much more shading taking place, is more appropriate to know that the each of the segment fees is an average unit cost and we’ve a volume there are not pay for. The impact of that in the reclassification actually was I think relatively remainder that was a, just about 1% point and the, and networking and transportation are with 0.6, 0.7 with in our wireless business. As we go forth again as we said earlier we will be looking at the, the goals for each of the segments, obviously as Michel said we both are going to still more satisfy we continue to raise the bar and I think where we would asked to just hold often, we owners giving some additional color on some of those models when going forward.

Q - Tim Lash

Sure.

A - Michel Mayer

That’s your, your strategic I got the question, I mean we, we’ve said very clearly from the beginning that business that do not perform to a satisfaction might be looked back, but I mean at this point we are still very committed to that business we like it it’s a, we were getting significant growth in 15 and 32 bit, the consumer electronic part of the business is, is improving very nicely internal outstation in particular. As we are able to, in position resources which we’re serving low margin printer and automotive analog opportunity then we’ve able to reposition them to attract growth opportunity and then that’s a little bit and then its going to be interviewing in the case, some of the quick and quick confirmation that you see of the STG model but that were more to come as we, as we…

Q - Tim Lash

One follow up, given, given that in your access cash position you see opportunities either to, of the mark capital structure further buyback more stock, it seems as through you’re operating with the nice war chest, what are, what are you looking you looking at and how did you look at enhanced value for shareholders.

A - Michel Mayer

Yeah at this point, we got inspiring with our current model, we do communicate east and when appropriate that, at this point to the question I am really focusing the company on necessity and we’re on, we are focused on that.

Q - Tim Lash

Okay great thank you.

Operator

Thank you. Our next question comes from Mark Alocrum (ph) of the Benchmark Company. You may ask your question.

Q - Mark Alocrum

Yeah thanks, first of all congratulations on the execution your stock has done very well from the IPO and you have beaten your guidance almost every quarter, and yes congratulations for the whole team.

A - Alan Campbell

Thank you. It’s the record we’ve beaten our guidance every quarter.

Q - Mark Alocrum

Yes, yes you have. Yes, few questions here you have #1 is that on the margin side, I know that here quite a lot of time has been spent in trying to explain that, I mean you are at a $5 billion semiconductor company with 87% of the manufacturing internally. What I am trying to figure out is that when would your sales, AKA your capacity utilization going up and down would start increasing the margin more than what it has been. In other words can you give us an idea that out of the 200 to 300 improvement in the margin, we’re talking about the next 2 years time or so, how much of that is depending on your internal manufacturing efficiency and the mix and how much of that is going to be depending on the market condition?

A - Alan Campbell

Now let me try to take that one that, let me thanks that we, we’ve tried to put focus improvement with that depending solely on market conditions on revenues. So one of our challenges is as we drill that in a non-improving is to come out with the details that will, get our improvement with over revenue growth. Most of the, the numbers that Michel talked about in terms on health improvement will come as a result of our internal factories; although but we are going to very focused on supply chains. We said supply chain was a big element yield which is our internal factories in the big element. But we are not going to be as, we’ve not done in the past being specific and breaking down the operational efficiencies by, by the subcategories.

Q - Mark Alocrum

In other wards it is 200 to 300 basis point improvement or would not be too much dependent on the market condition.

A - Alan Campbell

The market can not so much, the market conditions are obviously going to help and give us tail enders we’ve said before but again our management philosophy in the show and I as, we want to continue to improve what we can control and know what the market controls.

Q - Mark Alocrum

Just if I may, just a follow up question, on the wireless book-to-bill you give a book-to-bill of 0.97, is that different and is that because of the seasonality of the wireless market or its something else going on out there.

A - Alan Campbell

Well I don’t think I would worry too much of both, I mean if you think about the third quarter our book-to-bill was reporting the third quarter was 1.3. So, I wouldn’t, first the fact the, book-to-bill about wireless uniquely by far the least reliable of our, of our three units for very that it very dependent come one last customer order and, and those tend to fluctuate. So I would, I would not focus too much on that, on that number. Okay thank you lets go to the next question. Operator?

Operator

Thank you. Next question comes from Shawn Slayton of SG Cowen. You may ask your question.

Q - Shawn Slayton

All my questions have been answered thank you.

A - Michel Mayer

Okay great. So that gives you an opportunity to close the call. Thank you and have a good evening thank you very much. Bye, bye.

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Source: Freescale Semiconductor Q4 2005 Earnings Conference Call Transcript (FSL)
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