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Executives

Mitch Haws – VP of IR

Gregg Lowe – President and CEO

Alan Campbell – SVP and CFO

Analysts

John Pitzer – Credit Suisse

Glen Yeung – Citi

Jim Covello – Goldman Sachs

Earl Hege – RBC Capital Markets

Franklin Jarman – Goldman Sachs

Ross Seymore – Deutsche Bank

C.J. Muse – Barclays

Ambrish Srivastava – BMO Capital Markets

Jeff Harlib – Barclays

Arun Seshadri – Credit Suisse

Jake Kemeny – Morgan Stanley

Freescale Semiconductor, Inc. (FSL) Q2 2012 Earnings Call July 19, 2012 5:00 PM ET

Operator

Welcome to Freescale’s second quarter 2012 results conference call. (Operator Instructions). This 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

Thank you and welcome to all of you to our second quarter 2012 earnings conference call. With me today are Gregg Lowe, our President and Chief Executive Officer, and Alan Campbell, our Chief Financial Officer.

Before we begin the prepared remarks today, let me remind everyone that today’s discussion contains forward-looking statements that are based on our current outlook, and as such, do include risks and uncertainties. Please refer to our press release, Form 10-K, and other filings with the SEC for more information on the specific risk factors that could cause actual results to differ.

Also today we will reference non-GAAP financial measures, and we will post the appropriate GAAP financial reconciliations to our website at freescale.com. Today’s call is being webcast live on our website at freescale.com.

With that, I’ll turn the call to Gregg Lowe.

Gregg Lowe

Good afternoon and welcome to our second quarter earnings call. As most of you know, this is my first earnings call with Freescale. I'm excited to be here and very upbeat about the opportunities ahead of us. I’ll spend a couple of minutes highlighting our Q2 results, after which Alan will provide some additional commentary and insight into the financials. Following Alan’s comments, I’ll share some initial observations about Freescale, and then we’ll entertain questions.

As expected coming into the quarter, our results improved on a sequential basis. Revenues grew 8% to $1.029 billion, gross margins increased 50 basis points to 42.8%, adjusted net earnings were $17 million and adjusted EPS was $0.07.

Also during the quarter, Freescale hosted another very successful Technology Forum in San Antonio. We hosted more than 2,200 attendees over 10 days, including over a thousand customers, 400 partners and distributors, hundred university educators, and a hundred suppliers. During the event, more than 360 hours of in-depth and hands-on technical training sessions were completed. Many of you attended the event and saw first hand a number of innovative new products will be rolling out to customers in the coming months.

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

Alan Campbell

Well, good afternoon and thank you again for joining today’s call. As I review the Q2 financial results in more detail, please note that I will be focusing on the results excluding the impact of certain 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 price accounting adjustments are no longer material.

Now looking in Q2 in more detail, revenues were $1.029 billion, representing a sequential increase of 8%. Sales declined by 16% compared to Q2 of last year. AISG product sales in Q2 were $568 million, 8% above the first quarter and 10% below Q2 of last year. Sales to both of our automotive and industrial markets grew sequentially. Year over year, revenues declined in both automotive and industrial given the strong demand following the earthquake in Japan in early 2011.

And MSG revenues were $335 million in the quarter, up 6% from Q1 but down 21% from Q2 last year. Sequentially, sales benefited from growth in both wireless and infrastructure and enterprise. Sales of our application processes to the consumer market increased sequentially as well. And year over year, net working revenues were negatively impacted by lower demand, primarily in the wireless and infrastructure market.

Our cellular product sales were $50 million compared to $66 million in Q1 and $122 million in Q2 of last year. Other products, which again primarily consist of IP revenue and patent sale, resulted in quarterly net sales of $76 million compared to $40 million in the first quarter and $44 million last year. The increase in sales was driven by multiple IP licensing and patent sale transactions completed in the quarter. And I will provide additional detail on the transactions later in the call.

Finally, sales to distribution were flat sequentially and were down 20% compared to last year. Recall that the first half of 2011 was quite strong in the distribution channel. Looking at our distribution [inventory] was essentially flat compared to Q1, and weeks [inventory] decreased from 10.7 in Q1 to 9.6 in Q2. Our book-to-bill ratio in the second quarter was 0.98 compared to 1.05 in the first quarter.

Now looking to gross margins and operating expenses, our gross margins were 42.8% compared to 42.3% in the first quarter. The gross margins benefited from higher IP licensing revenue and overall operating efficiency. Offsetting this benefit was the impact of a lower margin product mix and lower overall front-end utilization as we began the process of eliminating production in our Toulouse, France facility. We expect to complete final outs from this facility during the third quarter.

Compared to Q2 of last year, adjusted gross margins were down 280 basis points, primarily due to lower sales volume and the impact of product mix. Our internal front-end factory utilization was approximately 76% in the second quarter. This compares to 81% in the first quarter and 78% in Q2 of last year. As I mentioned earlier, the major change in utilization result related to the transition underway at our Toulouse facility.

Now looking at operating expenses, as we highlighted coming into the quarter, our operating expenses grew sequentially but remained close to a target of 28% of revenue. Overall operating expenses were below the same period last year. Our SG&A was $116 million at 11.3% of sales, above the first quarter due to an increase in marketing spend and stock compensation. Total SG&A dollars declined $21 million over last year as we managed discretionary spend and incentives.

R&D in the quarter was $188 million or 18.3% of sales. And this compares to $181 million in Q1. Total R&D spend declined $19 million from Q2 last year, again due to managing discretionary expenses and incentives.

As the level of investment in R&D continues to support the growth initiatives we’ve targeted in our core markets and product areas, adjusted operating earnings were $136 million or 13.2% of sales. This compares to $119 million in Q1 and $216 million in the second quarter of last year. Our adjusted net earnings were $17 million exclusive of reorganization charges, stock-based compensation and other adjustments included in today’s earnings release. This compares to an adjusted net loss of $9 million in Q1 and adjusted net earnings of $70 million in the second quarter of last year. Adjusted earnings per share exclusive of the adjustments mentioned earlier was $0.07 compared to adjusted net loss of $0.04 in Q1 and $0.33 in the second quarter of last year.

Our EBITDA in the second quarter was $192 million or 18.7% of sales, and this compares to $183 million in the first quarter and $292 million for the same period last year. Our adjusted EBITDA was $1.02 billion on a trailing 12-month basis.

During the second quarter of 2012, $20 million was recorded in the reorganization of business, which was related to the change in the executive leadership of the company. The majority of this amount was a charge due to indemnification related to our current CEO’s former employer. We also recognized costs related to the successful transition of duties of our former Chairman and CEO.

Now looking at cash, we made modest progress in the second quarter, with working capital which represented a $9 million source of cash in the quarter. Our accounts receivables, days of sales outstanding were 39 in the quarter. This compares to 41 in Q1 and 35 in the same period last year. Payable days were at 56, and this compares to the 57 in the first quarter and 55 days in the second quarter of last year.

Inventory dollars were up modestly from the first quarter, approximately $4 million. However, total inventory days declined sequentially to 125. This compares to 134 in the first quarter. Inventory days were at 100 in Q2 of last year. And excluding the inventory related to the Toulouse transition, our inventory days were at 116 days.

Cash, cash equivalents were $881 million, and this compares to $760 million in the first quarter. The increase in cash was related to multiple IP licensing and a patent sale transaction completed during the second quarter. Combined, these transactions generated $144 million in cash proceeds during the quarter. Over time we expect total cash proceeds of $287 million from these transactions. The remaining cash will be received over the next seven years but the majority expected to receive in the next 12 months.

IP revenue associated with these transactions for the second quarter was $58 million. The remaining revenue will be recognized over the coming quarter based on certain deliverables outlined in these agreements. We anticipate IP revenue to be back to our normal range of approximately 4% of sales in the third quarter.

Capital expenditures for the quarter were $35 million or 3% of sales. Given our consistent execution on managing cash, we continue to have solid liquidity. Our cash and cash equivalents coupled with the undrawn revolver of approximately $400 million affords us the opportunity to continue to invest in the business, fund our capital expenditures and continue to de-lever.

Finally, I’d like to provide an update on the progress we’ve made on the closure of our two remaining 150 mm fabrication facilities in Japan and France. The process of completing the transaction from the Sendai, Japan facility is completed following the accelerated schedule we started in March 2011 following the earthquake. At this time, the product qualifications and transitions have been completed.

With respect to the facility in France, we have been working for several quarters with our customers to transition production to our own 200 mm facilities in the US. We expect final production from the facility to be completed during Q3. And as mentioned previously, we expect gross margin benefit from this closure to begin in early 2013.

I’ll now take a few minutes to discuss our guidance for the third quarter. Based on our current outlook, we expect Q2 revenues to be in the range of $955 million to $1.005 billion. On a sequential basis, our core product revenues will be essentially flat with that in Q2. Our IP revenues will declined to a more normal historical level of 4% of sales. And our cellular revenues will also decline to approximately $25 million as we exit the business with one or two of our remaining -- of one of our two remaining customers. Finally, we expect gross margins to decline by approximately 75 basis points from Q2 based on lower sales and a decline in capacity utilization.

With that, I now would like to turn the call back to Gregg.

Gregg Lowe

Thanks, Alan. Before we move to the Q&A session, I wanted to give you some initial perspectives on what I’d found in my first month-and-a-half at Freescale and what I plan to focus on during the coming months.

I spent considerable amount of time getting to know the employees at Freescale. I’ve met with literally hundreds of employees from all across the company. I'm impressed not only with the talent here but also by the commitment of the employees to winning in the marketplace. There is a large untapped potential among the employees here, and a key focus of mine and the management team will be finding new ways to leverage that talent and enthusiasm.

We have a loyal and commitment customer base. During the Technology Forum and in several meetings since that event, I’ve met with many customers and distribution partners. They like our products and roadmaps and are eager to continue working with us on their next-generation designs.

A key challenge we’ve had as a company is top-line growth and market share expansion. And this has been a challenge at Freescale for sometime. Our primary focus over the coming weeks will be to complete a review of each product group and each core market served within the company. We will complete an analysis of the market potential, our strengths and weaknesses, and assess the potential for us to make a meaningful impact in the market, deliver top-line revenue growth, market share gains and margin expansion.

This will likely lead to changes in how we allocate our OpEx, shifting resources into areas that we believe will help us increase top-line growth and expand our margin. While we are early in the process, we do expect to complete this assessment during Q3 and be in a position to communication our plans with all of our stakeholders in Q4.

In the meantime, we will continue to scrutinize expenses that do not impact our ability to grow. As an example of this, we have decided to eliminate the Freescale corporate jet and the associated flight operations. This represents a significant savings for the company and will have zero impact on growth.

We’re approaching all of our decisions with a combination of urgency and thoughtfulness, and we’re committed to getting Freescale back on a path to growth.

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

Question-and-Answer Session

Operator

Thank you. (Operator Instructions).

Our first question comes from John Pitzer with Credit Suisse.

John Pitzer – Credit Suisse

Yeah, good afternoon, guys. Alan, just a quick question on the balance sheet. Accrued liabilities jumped pretty significantly kind of from the March to the June quarter. Can you help me understand what drove that in the quarter please?

Alan Campbell

Yeah, we have -- John, that’s a good question -- we have an increase associated with the IP licensing. We discussed the IP licensing, that we were able to recognize additional revenues in the quarter. We did receive approximately $140 million associated with that. We do anticipate, John, also to receive additional cash proceeds over the next year of probably in the range of $100 million. And that’s the main reason for the increase.

John Pitzer – Credit Suisse

And then I'm sorry if I missed this, but utilization expectations for the September quarter relative to the gross margin guidance is what? And relative to kind of your plan to try to manage inventory, would you expect September to be a trough in utilization?

Alan Campbell

Yes, so we have -- we’ve taken quite an aggressive position with the utilization. If we put it in perspective, John, and we’ll take the Toulouse factory out of this since that will be closed in Q3, and we look at our remaining [Eans] facility, we expect our utilization, our front-end utilization, to drop 400 to 500 basis points. As a result, obviously, that is going to have quite a significant impact on the margin, and as a result, the margin guidance. As we’ve said before, if you think about for every point reduction in utilization, the gross margin impact will be about 25 basis points of that. So that has had a significant impact on the guidance.

John Pitzer – Credit Suisse

And then Alan and/or Gregg, you’re kind of guiding sort of the core business kind of flat sequentially. Is that sort of the right way to think about the different buckets, autos versus network processing? And help me understand how much you think this is macro-related versus you guys kind of potentially losing share under growing markets?

Gregg Lowe

The guidance essentially is, as you had mentioned, it’s flat for the core businesses, if you will, of NMSG and AISG. NMSG, if you look underneath it, is flat to slightly up, and the automotive business is flat to slightly down. And normally I guess in third quarter we would anticipate a kind of a weaker automotive business. So, flat to slightly down is kind of in line if not a little bit better than normal seasonality, I would say.

Certainly, the macro environment is impacting both NMSG and AISG. The other two aspects of the business are the IP and the cellular business. As Alan had mentioned, we’ll see another tranche of headwind for the cellular business with the completion of sales to one of the two remaining customers and the IP business will go back to its normal run rate.

John Pitzer – Credit Suisse

Great. Thanks, guys. Appreciate it.

Operator

Thank you. Our next question comes from Glen Yeung with Citi.

Glen Yeung – Citi

Thanks for letting me ask a question. Greg, this is for you. As you go through this analysis of Freescale and its market over the course of the third quarter, and while you're doing that realized that utilization rates are still falling, does the figure -- is it possible in the future that you may reconsider the advantage you have left at this point and what you might do with them?

Gregg Lowe

What I plan to do right now from a strategy standpoint is to complete the evaluation that I had talked about and looking at each of the product areas and each of the different markets that we serve and really looking at that -- at those businesses and the markets with a view of what is the market potential, what are our strengths and weaknesses, and really what’s our ability to make an impact and deliver great stuff for our customers that will drive revenue growth and margin expansion. So that’s really the focus.

I think the near term, from a manufacturing standpoint, the team has obviously done a great job of closing two facilities and dealing with the transfers of products associated with that. Near term, we face an uncertain environment, so, in order to be prudent with respect to inventory levels, we’re going to take utilization down this quarter to keep our inventories in check.

Glen Yeung – Citi

Okay, probably a good thing to do. Maybe as a follow-up then, can you give us some sense of order, linearity as it progress through the June quarter, and then maybe any impact you may have as we’ve begun the third quarter.

Alan Campbell

Yeah, let me take that one, Glen. We saw a little bit of a change in the pattern of new orders coming on to the books. Each week in the month of April and the month of May, new orders were very strong. That continued into the initial part of June, and middle to the latter part of June we did see weakness on those new orders, and that has continued into the first two weeks of July. With the guidance that we’ve given, that is recognized [inaudible].

Glen Yeung – Citi

And is there any granularity in terms of geographical strength or weakness?

Alan Campbell

No, actually there isn’t -- I would say we have seen in the auto side a little bit more weakness specific to Europe. And networking side really across the board, I shouldn’t say weakness, it’s relatively flat, but it’s not strength, so it’s all relative.

Glen Yeung – Citi

All right. Thank you, guys.

Operator

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

Jim Covello – Goldman Sachs

Great. Thanks so much for letting me take -- ask a question. And I apologize if you covered this already, but the order trajectory as we went throughout the quarter, did the orders weaken toward the end of the quarter, or was the softer environment apparent earlier in the quarter and then things have kind of flattened out? I'm just trying to get at if we’ve hit what we think is a steady state in this new environment, are there still some risk to the downside?

Alan Campbell

Yeah, Jim, thanks. Glen also just asked that question. The orders pattern in April and May was very strong each week, and to early June it continued. Middle of June to late June had tended to weaken. It improved slightly in July but not to the same rates of April and May. And that’s why we had given the guidance that we’ve given.

Jim Covello – Goldman Sachs

Terrific. Apologies for asking the double question, I'm just trying to manage multiple calls. Thanks a lot.

Operator

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

Earl Hege – RBC Capital Markets

Hi, this is Earl Hege calling in for Doug Freedman. Just looking at your guidance, what your turn assumption there?

Alan Campbell

Yeah, so it’s very -- it’s reasonably consistent I would say with the industry. As we enter into the quarter, we historically have had 85% to 90% of our orders or backlog on the books, and that is reasonably consistent, and again, as a result of the guidance we’ve given.

Earl Hege – RBC Capital Markets

Okay, great. And where are your lead times currently? And in addition, are you seeing any impact of order push-outs or cancellations?

Alan Campbell

Lead times have been holding very steady, and we have not push-outs. We do keep a very close -- we have a lot of metrics on this and we have not push-outs, we’ve just seen a slower order pattern taking place.

Earl Hege – RBC Capital Markets

Okay, great. Then last question if I could, from an end-market perspective, can you comment on current trends, what are your stronger and weaker end-markets and when could you potentially see any signals, I mean an inflection point, and a more impacted end-markets? Thank you.

Alan Campbell

Yeah. So if you think about the Q2 results, first of all, and end-markets, we did see growth across all end-markets, so in the automotive space we saw our revenues grow 9% and our networking space it grew 5% and our consumer space it grew 10% and industrial space it grew 7%. So, pretty health growth looking into the second quarter. That was offset, as we said in the call, with our wireless business dropping off.

As we look out into the third quarter, we are seeing our auto being relatively flat to slightly down. This is somewhat consistent with the seasonality of that type of business. We are seeing in networking it could be flat to slightly up, and we are seeing an increase in consumer. We’re also seeing an increase in industrial.

So, in terms of those markets, that’s the guidance. And as mentioned on the call earlier, we are seeing wireless continue to decline, as well IP revenues. But the core businesses are flat to slightly up.

Operator

Thank you. Our next question comes from Franklin Jarman with Goldman Sachs.

Franklin Jarman – Goldman Sachs

Great. Thanks for taking my questions, guys. I guess the first question I had was just with regards to the cash in the balance sheet, it did increase a little bit this quarter. I know you’ve talked historically about running with around $750 million of cash on hand. How are you thinking about managing the cash in the balance sheet going forward? Would you consider running with a little bit more cash just given the expected increase in leverage in the challenging operating environment we’re seeing right now.

Alan Campbell

Yeah, Frank, I would say overall we’re very comfortable with the cash position, as we’ve communicated in the past. We have said that the minimum kind of cash balance, we want to operate with $750 million, although we have also communicated that we could operate at a lower level than that. And we did increase the cash balance by some $120 million in the second quarter. A lot of that was driven by proceeds from the IP. And our key area here, as we said before, we’ll continue to invest in the business, we’ll continue to look at the opportunity to de-lever, and we’ll also look at the smaller tuck-in acquisitions, and that continues to be our mode of operation.

Franklin Jarman – Goldman Sachs

Great. And then just with regards to the Toulouse, France plant closure, you made some comments in the opening remarks about how you plan for savings to really start to impact the income statement in the first quarter of 2013. Can you just remind me how we should think about that from a cost reduction standpoint and what the incremental savings should be as they roll on in 2013?

Alan Campbell

Yeah. So we’ve said that the annualized savings associated with this closure will be $70 million. So that represents roughly about $17 million per quarter. In terms of the progression of that, we will see that kicking in, in the first quarter of 2013 and getting to [kind of fill] run rate of the $17 million per quarter by the second quarter of 2013.

Franklin Jarman – Goldman Sachs

Okay, great. Thanks so much.

Operator

Thank you. Our next question comes from Ross Seymore with Deutsche Bank.

Ross Seymore – Deutsche Bank

Hi, guys. Both in the quarter and in the guide, can you give a little more color on what you saw on the working side of business between the wireline and wireless side or the digital and RF side, whatever that color you can give would be helpful. Thanks.

Alan Campbell

Yeah. Ross, I’ll take that. [Firstly], we won’t have additional color to it. But overall it was fairly consistent. We don’t see in the service provider infrastructure side, that was relatively flat. Overall I would say the digital networking [kind of holds in there] from a market standpoint. The GSM side for us, which we’ve talked about in the past, continues to be relatively flat, we’re down versus last year, and as is the enterprise side as we look out into the first quarter.

Ross Seymore – Deutsche Bank

And then I guess looking into the third quarter, and if you can, even into the full second half, how should we think about operating expenses?

Alan Campbell

Yeah, so we expect operating expenses to be slightly down, flat to slightly down, I would suggest, for the third quarter.

Ross Seymore – Deutsche Bank

And is there -- if the revenue stays muted given the macro economy, is this a level that’s kind of the new base or is that more dependent on some of the strategic findings that Gregg highlighted earlier?

Gregg Lowe

Well, obviously we’re going to be very prudent, very thoughtful and very urgent on that issue, as I talked about. We’re relatively early through the process, but as I said, we should be concluding that process by third quarter, by the end of third quarter, and communicating all of the ramifications and the changes associated with that in the fourth quarter.

I think you should definitely expect that we would be changing where we would be spending money and be focusing that spend in areas that are going to help us drive growth and margin expansion.

Ross Seymore – Deutsche Bank

Just one little one, if I can sneak it in. Inventory expectations on your books sequentially on a dollar basis?

Alan Campbell

For the second quarter, inventories were slightly up by $4 million. These were down by about nine days. Our expectation is, as we look into Q3, for inventories to be flat to slightly down, and days following that type of pattern.

Ross Seymore – Deutsche Bank

Great. Thank you.

Operator

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

C.J. Muse – Barclays

Yeah, good afternoon. Thank you for taking my question. I guess first question, in terms of utilization dropping down to the low 70s, curious, if we do see business trends kind of stay at current muted levels for the core business, does that get you where you want your inventories to be I guess both in terms of your overall inventory, die bank inventory, as well as in the distri channel?

Alan Campbell

It does, but let me put some color to that. We historically made a decision to build inventory, to build a die inventory to be ready for the upside. With the macro conditions, that has not materialized. As a result, we have had the breaks on the factory production levels, and we expect, obviously with the utilization coming down, 400 to 500 basis points that will start [inaudible].

Our days inventory today, excluding the end-of-life products associated with the closure of the French facility, at 116 days. That is still high. We do anticipate though that that will and can come down, driven by some of the utilization reductions but also driven by somewhat of an improving market as we look out into Q4 and into next year.

Gregg Lowe

And distribution weeks of sales declined from 10.5 to 9.6 from Q1 to Q2.

C.J. Muse – Barclays

Great. And in terms of your rule of thumb of one point utilization, 25 bps gross margin, once we have both fabs closed, does that change at all or is that what we should be thinking about go-forward?

Alan Campbell

Actually has changed a little bit from past, because we did see in the past that we were expecting a 30% fall-through for every -- or 30 basis points for every point reduction in utilization. So it will start to fall as the factories get more fully utilized, but in the short term, in the coming quarters, 25 basis points is reasonable.

C.J. Muse – Barclays

Got you, it’s helpful. And if I could sneak one last one in I guess, in terms of typical seasonality, curious what you typically, and not for kind of the two other businesses but really on the core side, networking, industrial, audio -- auto, what do you typically see for Q4?

Alan Campbell

Yeah. So we actually see growth into Q4 from a seasonality standpoint. It does vary by business. So if I take the AISG, the automotive, industrial segment first of all, historical seasonality is down in Q3 by a couple of points and up in Q4 by two or three points. We are guiding on the guidance we’ve given for AISG to be relatively flat.

In the networking business, it’s a little bit more difficult when you look at the seasonality over the last 10 years, but directionally I would say it would normally be flat to slightly up in Q3 and up again in Q4 by the mid-single zero to 5% type range.

C.J. Muse – Barclays

Very helpful. Thank you so much.

Operator

Thank you. Our next question comes from Ambrish Srivastava with BMO.

Ambrish Srivastava – BMO Capital Markets

Hi. Thank you. Yeah, a couple of questions on the margin side, Alan. First, I'm just trying to bridge the gap on a year-over-year basis. And just based on the math you had highlighted in the past, that seems to be changing a little bit. But I'm looking at 46.1% a year ago and now you're guiding to 42%, and revenues are obviously down and utilization is down. But then Sendai cost savings should have been kicking in. So, help me understand the gap, because the math of 25 or 30 bps doesn’t get us there. So that was my first question.

And kind of related, more maybe for Gregg, and if I missed it, I apologize, are you taking the 53%, 55% target off the table until you do a complete comprehensive review, or is that still out there sometime in the future? Alan, if I remember correctly, you had pushed it last couple of times. Thanks.

Alan Campbell

Let me take the gross margin and I’ll let Gregg take the next question, if that’s okay. So the first point I’ll make is that, as we’ve communicated multiple times, we have many building blocks or elements on the gross margin improvement. We talked about utilization, we talked about operational efficiency. We talked about procurement savings, we talked about depreciation and we talked about portfolio. So these are the five building blocks. And these are still in check, and that’s important to say.

If you look at those, specifically to the question as to why is the margin down over the same period last year, the biggest driver of that is driven by the utilization. Our utilization last year was 83%, and as we said, dropped about 40, 50 basis points sequentially. So we’ve really gotten nearly 800 basis points of utilization that’s impacting us.

If we then take the different elements of that, we have seen improvements associated with Sendai, but unfortunately has been offset by the utilization. And there was a little bit of product mix embedded into the second quarter as well as the third quarter that has had a negative impact on margins. There’s also been a slight negative on the IP as we look out into third quarter. But that’s been offset also by some of the operational efficiency.

But just at the highest level, I would say that most of the margin reduction really is driven by the utilization issues that the company.

And I’ll make one comment and I’ll pass on to Gregg. I think if you think about the utilization today in kind of 76%, 77%, and you think a more normalized basis when we get back to our normal base of 90%, that is quite a significant increase obviously in utilization, which will then trigger gross margin improvement.

Ambrish Srivastava – BMO Capital Markets

Sorry, Alan, just one follow-up on that. You had also talked about the backend as being a contributor. Where are we at the backend utilization?

Alan Campbell

Yeah, the backend utilization from a year ago is down. I don’t have a percentage because of the number of assembly machines and test equipment, we don’t -- kind of summarize in totality. But it is down when you look at it on a sequential basis [inaudible]. But there is still opportunity for utilization to improve also in the backend.

Gregg Lowe

And then on the second part of your question, no, we are not taking that off the table at all. In fact, if you think about it, the objective of the analysis that we’re going through right now is to review the portfolio and focus our R&D efforts specifically, but focus our efforts in areas that we believe can substantially drive both revenue growth and margin expansion. And as I said, we’ve been quite urgent in driving that analysis. We anticipate that we could get through that here in the third quarter, and we’ll be giving you the details of that in the fourth quarter.

Ambrish Srivastava – BMO Capital Markets

And so, what’s the line of sight for the 53% to 55%, Gregg?

Gregg Lowe

I think it’s too early for me to tell. I mean, we’re still in the process of driving, you know, driving this analysis. So I would just ask that you give us the time to go through that in a very thoughtful and comprehensive way.

Ambrish Srivastava – BMO Capital Markets

That’s fair. Thank you.

Operator

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

Jeff Harlib – Barclays

Hi. Alan, can you provide a rough bridge on the gross margin Q1 to Q2 with IP royalties mixed, the utilization, et cetera?

Alan Campbell

Yeah, so, the utilization, as we said, Jeff, did drop from 81% to 76%. So we had a negative impact there. We had slight favorable on the procurement and depreciation. We also had a favorable on -- associated to the IP revenues. And that was slightly offset by some specific customer and product mix that we had in the quarter.

Again I would say that utilization really is driving most of the change at this point in gross margin. And we are confident obviously as that comes back, as the business comes back, we have that capacity to react to it and also improve our gross margin.

Jeff Harlib – Barclays

Okay. So, do you have what the IP benefit was in terms of percentage?

Alan Campbell

We don’t disclose the specific in that, Jeff.

Jeff Harlib – Barclays

Okay.

Alan Campbell

I will say though that the IP revenue does contribute higher than corporate margins overall. So that had a benefit to the overall gross margin in the second quarter.

Jeff Harlib – Barclays

Okay, okay. And just on the remaining cash restructuring costs for Toulouse, can you just update us on the timing of that and quantify?

Alan Campbell

Yeah. So we have approximately $100 million of cash costs related to the payments that we’ll make to the employees as a result of closing this facility. The profiling of that cash will be $40 million at the end of this year and $60 million getting into 2013. It’s embedded in all our cash flow [outcomes], et cetera. So, obviously we don’t see that as an issue from a cash standpoint.

Jeff Harlib – Barclays

Okay. And just last question, on the IP royalty and patent sales, does that take away from your kind of quarterly run rate going forward or are these kind of additional sales that don’t, you know, shouldn’t affect your future IP royalties?

Alan Campbell

Yeah, I would say that in terms of modeling, it’s probably reasonable to use kind of 4%, 3.5% to 4%, for the IP as we go forward. As we said, there won’t be incremental cash coming in, in the fourth quarter and early 2013 as a result of some of the transactions we executed in the second quarter.

Jeff Harlib – Barclays

Okay. Thank you.

Operator

Thank you. Our next question comes from Arun Seshadri with Credit Suisse.

Arun Seshadri – Credit Suisse

Hello, gentlemen. Thanks for taking my questions. First, I just wanted to ask, on, you know, based on normal order trends, at this point, how much visibility do you traditionally have into Q4 and kind of where you are right now visa vie that?

Alan Campbell

Yeah, we have some visibility, obviously, it’s not just visibility into the orders placed on the books. When you look at the customer base that we have, the diversification, we do get a lot of signals and sound bites from each other’s customers into what they’re thinking about in Q4. We look at Q4 in a number of different ways. We look at how is the backlog gauging in, we look at how is the book-to-bill in the third quarter, we look at customer feedback, and we look at normal historical seasonality. But it’s a little bit early to talk specifically about backlog against the fourth quarter.

Arun Seshadri – Credit Suisse

Okay, fair enough. And then generally speaking, what is the potential for you to divest backend facilities, or put another way, are there any constraints to outsourcing more backend and potentially realizing asset sale proceeds to pay down the debt on that avenue?

Alan Campbell

Well, there’s no limitation for us to divest. I mean there’s opportunities to do what we need to do in terms of running the business. Obviously it comes down to value and it comes down to cost, competitiveness of what’s the -- our right cost structure relative to buying from those sites, so there’s a lot of variables there. But there’s no limitations for us to do that.

Arun Seshadri – Credit Suisse

Okay, fair enough. Thank you.

Operator

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

Jake Kemeny – Morgan Stanley

Hi, Alan. I just had another question on the IP sales. I think you said there was $58 million of revenue recognized in the quarter. How does that compare to typical quarters? Like how much incremental did you recognize versus what you’d traditionally do?

Alan Campbell

Yeah, I think the easiest way of looking at that, if you look at the segment revenues embedded into our release, you’ll see that the other segment, which includes IP, increased from $30 million to $76 million. So as we’ve said before, in terms of our normal run rate, probably $30 million, $35 million is more of a normal run rate. So that gives you an indication of what the relative increase was.

Jake Kemeny – Morgan Stanley

So the incremental was from that kind of $30 million to $35 million to $58 million, so like an incremental almost $30 million of revenue?

Alan Campbell

Yeah, the $58 million actually referred to the specific transactions that we entered into the quarter. There’s also ongoing revenues associated with IP. So the incremental really was in the $30 million to $35 million, which is our normal base, and that compares to the $76 million that’s embedded into the statement.

Jake Kemeny – Morgan Stanley

Okay. And I just want to try to get back to like what Jeff was asking about before, the EBITDA that you reported, the $192 million, I mean how much of that do you think -- how much of that includes the incremental from these IP sales that you recognized this quarter?

Alan Campbell

Again, embedded into our revenue number, first of all, which was $1.029 billion, as the about $70 million of IP revenue, so IP revenues were just below 7%. So that does fall through to EBITDA. We don’t disclose that is above the company average. So if you take the company average north, up a little, you can probably calculate it, but I don’t think it’s appropriate going in and talk about specific margins with any segments of our business or IP. But that contributes to some of the margin improvement, some of the EBITDA improvement.

Jake Kemeny – Morgan Stanley

Okay. Thank you.

Gregg Lowe

Okay. Well, thanks, everyone, for participating in today’s call. As always, if you have follow-up questions, Alan and I are available tonight after the call and tomorrow. Thank you very much for your time.

Operator

Thank you. This concludes today’s conference, you may disconnect at this time.

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