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FSL > SEC Filings for FSL > Form 10-Q on 26-Apr-2013All Recent SEC Filings

Show all filings for FREESCALE SEMICONDUCTOR, LTD. | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for FREESCALE SEMICONDUCTOR, LTD.


26-Apr-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following is a discussion and analysis of our results of operations and financial condition as of and for the three months ended March 29, 2013 and March 30, 2012. The following discussion of our results of operations and financial condition should be read in conjunction with our consolidated financial statements and the notes in "Item 8: Financial Statements and Supplementary Data" of our Annual Report on Form 10-K/A filed with the Securities and Exchange Commission on March 7, 2013 ("Annual Report"). This discussion contains forward looking statements and involves numerous risks and uncertainties, including, but not limited to, those described in the "Risk Factors" in Part I, Item 1A of our Annual Report. Actual results may differ materially from those contained in any forward looking statements. Freescale Semiconductor Ltd. and its wholly-owned subsidiaries, including Freescale Semiconductor, Inc. ("Freescale Inc."), are collectively referred to as the "Company," "Freescale," "we," "us" or "our," as the context requires. Our Business. We are a global leader in microcontrollers (MCUs) and digital networking processors. These embedded processing solutions are the keystones of the emerging Internet of Things, a network of smart devices that will help make our lives easier, safer and more productive. We complement our embedded processors with analog, sensor and radio frequency (RF) devices to help provide highly integrated solutions that streamline customer development efforts and shorten their time to market. Our product and strategy focus is on the need for increased connectively and enhanced intelligence that is at the heart of the fastest growing semiconductor applications. Growing electronic content in automobiles, increasing demands for networking bandwidth, connected industrial and medical electronics and the proliferation of smart mobile devices are the growth drivers of our business. We have a heritage of innovation and product leadership spanning over 50 years and have an extensive intellectual property portfolio. Our close customer relationships have been built upon years of collaborative product development.
The trend of increasing connectivity and the need for enhanced intelligence in existing and new markets are the primary drivers of the growth of embedded processing solutions in electronic devices. The majority of our net sales is derived from our five product groups. Our Microcontrollers product line represented 18% and 16% of our total net sales in the first quarter of 2013 and 2012, respectively. MCUs are a self-contained embedded control system with processors, memory and peripherals on a chip. Combined with applications processors, we deliver solutions for industrial, smart energy, healthcare and multimedia applications. Our Digital Networking product line represented 21% and 22% of our total net sales in the first quarter of 2013 and 2012, respectively. We offer a scalable portfolio of multicore communication processors and system-on-a-chip solutions for the networking and communication markets. Our products are at the heart of the telecommunications equipment, network infrastructure and general embedded connectivity nodes that are enabling the Internet of Things. Our Automotive MCU product line represented 26% and 25% of our total net sales in the first quarter of 2013 and 2012, respectively. Our Automotive MCUs are developed specifically for the critical performance and quality requirements of the automotive industry. We are driving the latest developments for powertrain, advanced safety and infotainment applications. Our Analog and Sensors product line represented 18% and 19% of our total net sales in the first quarter of 2013 and 2012, respectively. Our analog, mixed-signal analog and sensor products help capture, manage and transmit data from the real-world environment for embedded processing applications in the automotive, industrial and consumer markets. These devices complement our MCUs in applications for robotics, factory automation and automotive radar, braking and airbag control. Our RF product line represented 9% and 7% of our total net sales in the first quarter of 2013 and 2012, respectively. We are the leading supplier of RF high-power products for the cellular infrastructure market. We continue to expand our portfolio to leverage our RF technology leadership into the military, appliance, and automotive markets.
Reorganization of Business Program Activities. Following the appointment of Gregg Lowe as president and CEO of Freescale in June 2012, we completed a detailed review of our strategic direction to identify opportunities to accelerate revenue growth and improve profitability. In connection with this strategic realignment in 2012, we incurred approximately $40 million of employee termination benefits and other exit costs along with other non-cash charges. We began making payments to the employees separated under this plan during 2012 and we expect to continue making cash payments through the fourth quarter of 2013. We estimate annualized savings of $35 million to $40 million associated with these actions which we began realizing during the first quarter of 2013. We have completed a series of restructuring actions announced in 2008 and 2009 which included the closure of our remaining 150 millimeter manufacturing facilities in Toulouse, France and Sendai, Japan, as the industry evolved from 150 millimeter technologies and products to more advanced technologies and products. The Toulouse, France manufacturing facility ceased operations in the third quarter of 2012 following the scheduled end of production at the site. We estimate the remaining severance and other costs of this facility closure to be approximately $80 million, including $70 million in cash severance costs and $10 million in cash costs for other site decommissioning and exit expenses. We anticipate substantially all remaining payments will be made by the end of 2014; however, the timing of these payments depends on many factors,


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including the decommissioning of the manufacturing facility and local employment laws, and actual amounts paid may vary based on currency fluctuation. The Sendai, Japan facility ceased operations in the first quarter of 2011 due to extensive damage following the March 11, 2011 earthquake off the coast of Japan. The only remaining action to finalize the exit from this facility is the selling of the site. We may incur additional charges associated with preparing the facility site for sale, which we expect to be offset with proceeds from the sale.
The Company has previously estimated that it expected to receive approximately $120 million in annualized savings once the closure process has been completed and production moved to our remaining 200 millimeter facilities. As of the end of 2012, we had realized approximately $50 million of annualized cost savings related to the closure of the Sendai, Japan facility. We began realizing a portion of the $70 million in estimated annualized cost savings in the first quarter of 2013 associated with the closure of the Toulouse, France facility. We expect the remainder of the savings related to the closure of this facility to be realized throughout the remainder of 2013. Actual cost savings realized, and the timing thereof, will depend on many factors, some of which are beyond our control and could differ materially from our estimates.
Debt Restructuring Activities. During the first quarter of 2013, Freescale Inc. completed the Q1 2013 Debt Refinancing Transaction which amended the Credit Facility to allow for the issuance of new senior secured term loan facilities, the 2016 and 2020 Term Loans, in the aggregate principal amount of $2.7 billion, the proceeds of which, along with cash on hand, were used to prepay the 2012 Term Loan, the Extended Term Loan and the related fees and expenses associated with this transaction. The restructuring, among other things, (i) reduced the principal amount of indebtedness currently due in 2016, (ii) extended to 2020 the maturities of our indebtedness previously due in 2019 and a portion of our indebtedness previously due in 2016 and (iii) will increase our interest expense by approximately $3 million annually based on current interest rates. (Refer to "Liquidity and Capital Resources - Financing Activities" below for the definition and additional discussion of capitalized terms and transactions referenced in this section.)
Conditions Impacting Our Business. Our business is significantly impacted by demand for electronic content in automobiles, networking and wireless infrastructure equipment, industrial automation and consumer electronic devices. We operate in an industry that is cyclical and subject to constant and rapid technological change, product obsolescence, price erosion, evolving standards, short product life-cycles, customer inventory levels and fluctuations in product supply and demand.
In the first quarter of 2013, improving global economic conditions positively impacted our overall sales on a year over year basis. Our revenues improved 3% in the first quarter of 2013 as compared to the first quarter in 2012. Gross margin declined 170 basis points over the same period as a result of the annual price negotiations with our customers, product sales mix and lower utilization partially offset by higher intellectual property revenue, cost savings and improved yields.
Our revenues increased 3% and our gross margin increased 140 basis points in the first quarter of 2013 as compared to the fourth quarter of 2012. The sequential increase in gross margin is attributable to an increase in front-end wafer manufacturing facility utilization from 71% during the fourth quarter of 2012 to 79% during the first quarter in 2013 along with higher intellectual property revenues. During the first quarter of 2013, our backlog and order trends have improved as compared to the prior quarter. We began realizing these improvements to an extent through our distribution sales which increased 5% compared to the fourth quarter of 2012. The increase in revenue was driven by overall macroeconomic improvements and increased intellectual property revenues. Intellectual property agreements entered into during the second quarter of 2012 may limit our ability to sell or license some of our intellectual property to other parties through the second quarter of 2013 and may reduce our intellectual property revenues that are not associated with these agreements. In addition, we observed increasing backlog levels for our automotive customers over the course of the first quarter of 2013. We anticipate our total net sales and profitability for the second quarter of 2013 to improve on a sequential basis. Net sales in the second half of 2013 will depend on the extent and pace of a general global economic recovery, our ability to meet unscheduled or temporary increases in demand and our ability to meet product development launch cycles in our target markets, among other factors. Refer to Note 2, "Other Financial Data-Intellectual Property Revenue" for additional information regarding our intellectual property revenue. For more information on trends and other factors affecting our business, refer to Part I, "Risk Factors" in our Annual Report.


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Results of Operations for the Three Months Ended March 29, 2013 and March 30, 2012

Three Months Ended (unaudited) % of Net % of Net (in millions) March 29, 2013 Sales March 30, 2012 Sales Orders $ 990 100.9 % $ 999 105.2 % Net sales $ 981 100.0 % $ 950 100.0 % Cost of sales 583 59.4 % 548 57.7 % Gross margin 398 40.6 % 402 42.3 % Selling, general and administrative 111 11.3 % 102 10.7 % Research and development 182 18.6 % 181 19.1 % Amortization expense for acquired
intangible assets 3 0.3 % 3 0.3 % Reorganization of business and other (2 ) * (52 ) * Operating earnings 104 10.6 % 168 17.7 % Loss on extinguishment or modification of long-term debt, net (22 ) * (28 ) * Other expense, net (120 ) * (135 ) *
(Loss) earnings before income taxes (38 ) * 5 0.5 % Income tax expense 10 1.0 % 14 1.5 % Net loss $ (48 ) * $ (9 ) *
* Not meaningful.

Three Months Ended March 29, 2013 Compared to Three Months Ended March 30, 2012 Net Sales
Our net sales in the first quarter of 2013 increased by $31 million, or 3%, compared to the prior year quarter, and orders remained relatively flat over the same period. Distribution sales were approximately 24% of net sales and represented an increase of 3% compared to the prior year quarter. Distribution inventory, in dollars, was 9.2 weeks at March 29, 2013, compared to 9.7 weeks at December 31, 2012 and 10.7 weeks at March 30, 2012. The decrease in weeks of distribution inventory, as compared to the first quarter of 2012, was due to our distributors continuing to closely manage their inventory levels. Net sales by product design group for the three months ended March 29, 2013 and March 30, 2012 were as follows:

                               Three Months Ended
(in millions)          March 29, 2013       March 30, 2012
Microcontrollers     $     177             $            149
Digital Networking         202                          211
Automotive MCUs            254                          240
Analog & Sensors           177                          177
RF                          86                           67
Other                       85                          106
   Total net sales   $     981             $            950

Microcontrollers
Microcontrollers' net sales increased by $28 million, or 19%, in the first quarter of 2013 compared to first quarter of 2012 driven by increased distribution sales in Asia as well as higher sales of application processors sold into the general embedded and automotive markets.


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Digital Networking
Digital Networking's net sales decreased by $9 million, or 4%, in the first quarter of 2013 compared to the first quarter of 2012. Sales into the service provider and enterprise markets were essentially in line with the prior year, offset by a decline in sales of general embedded products as well as products sold through distribution.
Automotive MCUs
Automotive MCUs' net sales increased by $14 million, or 6%, in the first quarter of 2013 compared to first quarter of 2012 driven by the positive vehicle market trends in the US and China.
Analog and Sensors
Analog and Sensors' net sales were flat in the first quarter of 2013 compared to first quarter of 2012. We experienced higher sales into the automotive market, offset by declines in the consumer end market.
RF
RF's net sales increased by $19 million, or 28%, in the first quarter of 2013 compared to first quarter of 2012 driven by growth associated with increases in wireless basestation investments in China. Other
Other net sales decreased by $21 million, or 20%, in the first quarter of 2013 compared to the first quarter of 2012 due primarily to a decrease in cellular product sales, partially offset by an increase in intellectual property revenue. As a percentage of net sales, intellectual property revenue was 6% and 3% for the first quarter of 2013 and 2012, respectively. The increase in intellectual property revenue for the first quarter of 2013 related primarily to the intellectual property arrangements we entered into during the second quarter of 2012.
Gross Margin
In the first quarter of 2013, our gross margin decreased by $4 million compared to the prior year quarter. As a percentage of net sales, gross margin in the first quarter of 2013 was 40.6%, reflecting a decrease of 170 basis points compared to the first quarter of 2012. This decline in gross margin as a percentage of net sales was primarily the result of decreases in average selling price resulting from our annual negotiations with our customers that went into effect during the first quarter of 2013 along with changes in product sales mix primarily due to the decline in cellular product sales. We also experienced a decrease in utilization of our front-end manufacturing assets which contributed to declines in operating leverage of our fixed manufacturing costs. Front-end wafer manufacturing facility utilization declined from 81% during the first quarter of 2012 to 79% during the first quarter of 2013. Partially offsetting the decline were benefits to gross margin including increases in intellectual property revenue, procurement and productivity cost savings and improved yields. Selling, General and Administrative
Our selling, general and administrative expenses increased by $9 million, or 9%, in the first quarter of 2013 compared to the prior year quarter. This increase was primarily the result of higher incentive compensation during the first quarter of 2013 and lower discretionary spending in the first quarter of 2012. As a percentage of net sales, our selling, general and administrative expenses were 11.3% in the first quarter of 2013, reflecting an increase of 0.6 percentage points compared to the first quarter of 2012. Research and Development
Our research and development expense in the first quarter of 2013 approximated the amount in the prior year quarter. The impact of the employee transitions related to the strategic transformation program implemented in the fourth quarter of 2012 were offset by higher incentive compensation. As a percentage of net sales, our research and development expenses were 18.6% in the first quarter of 2013, reflecting a decrease of 0.5 percentage points compared to the first quarter of 2012.
Amortization Expense for Acquired Intangible Assets Amortization expense for acquired intangible assets related to tradenames/trademarks remained flat in the first quarter of 2013 compared to the first quarter of 2012 as these intangible assets have reached a normalized amortization run rate.


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Reorganization of Business and Other
In the first quarter of 2013, we recorded a net benefit of $10 million related to our Toulouse, France manufacturing facility which included a benefit for proceeds received for the sale of certain of our equipment and machinery and a partially offsetting charge related to on-going closure and decommissioning costs for this site. Additionally, we recorded $8 million of charges related to continued implementation of the 2012 Strategic Realignment plan, exit costs for underutilized office space and charges related to indemnification provisions included in our CEO's employee agreement.
In the first quarter of 2012, we recorded a benefit of $55 million for earthquake-related business interruption insurance recoveries related to our Sendai, Japan fabrication facility which suffered extensive damage from the March 2011 earthquake. This benefit was partially offset by $3 million of cash costs consisting primarily of on-going closure costs related to this site. Loss on Extinguishment or Modification of Long-Term Debt, Net In the first quarter of 2013, we recorded a charge of $22 million in the accompanying Condensed Consolidated Statement of Operations associated with the Q1 2013 Debt Refinancing Transaction, which included both the extinguishment and modification of existing debt and the issuance of the 2016 and 2020 Term Loans. During the first quarter of 2012, we recorded a charge of $28 million in the accompanying Condensed Consolidated Statement of Operations associated with the Q1 2012 refinancing transaction, which included both the extinguishment and modification of existing debt and the issuance of the 2012 Term Loan. (Capitalized terms referenced in this section are defined and discussed in "Liquidity and Capital Resources - Financing Activities.") Other Expense, Net
Net interest expense in the first quarter of 2013 included interest expense of $122 million, partially offset by interest income of $1 million. Net interest expense in the first quarter of 2012 included interest expense of $135 million, partially offset by interest income of $2 million. The decrease in interest expense is primarily due to the refinancing of long-term debt during the first quarter of 2012 and the redemption of $200 million in long-term debt during the second half of 2012.
Income Tax Expense
For the first quarter of 2013, we recorded an income tax provision of $10 million, which primarily related to our foreign operations. For the first quarter of 2012, we recorded an income tax provision of $14 million which included a $4 million tax expense associated with discrete events primarily related to withholding tax on intellectual property royalties. Although the Company is a Bermuda entity with a statutory income tax rate of zero, the earnings of many of the Company's subsidiaries are subject to taxation in the U.S. and other foreign jurisdictions. We incur minimal income tax expense on our U.S. earnings due to valuation allowances recorded on substantially all the Company's U.S. net deferred tax assets, as we have incurred cumulative losses in the United States. Our effective tax rate is impacted by the mix of earnings and losses by foreign taxing jurisdictions.
Reorganization of Business and Other
Three Months Ended March 29, 2013
2012 Strategic Realignment
As a result of the strategic review we completed during 2012 to identify opportunities to accelerate revenue growth and improve profitability, we have shifted our research and development investment and sales force to reflect this strategic realignment. In the prior year, we incurred charges to reorganization of business and other for employee termination benefits and other exit costs in connection with re-allocating research and development resources and re-aligning sales resources.


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The following table displays a roll-forward from January 1, 2013 to March 29, 2013 of the employee separation and exit cost accruals established related to the 2012 Strategic Realignment:

(in millions, except            Accruals at                                                              Accruals at
headcount)                    January 1, 2013          Charges          Adjustments          Used       March 29, 2013
Employee Separation Costs
Supply chain                $                6     $           -     $             -     $       (3 )   $          3
Selling, general and
administrative                              11                 -                   -             (4 )              7
Research and development                    13                 -                   -             (6 )              7
Total                       $               30     $           -     $             -     $      (13 )   $         17
Related headcount                          270                 -                   -            (60 )            210
Exit and Other Costs        $                2     $           6     $             -     $        -     $          8

The $13 million used reflects cash payments made to employees separated as part of the 2012 Strategic Realignment during the first quarter of 2013. The accrual of $17 million at March 29, 2013 reflects the estimated liability to be paid to the remaining 210 employees to be separated through the end of 2013 based on current exchange rates. Additionally, we recorded $6 million of exit and other costs related to (i) additional compensation for employees who were deemed crucial to the continuing implementation of the 2012 Strategic Realignment and
(ii) underutilized office space vacated in connection with plans to consolidate workspace in Austin, Texas. In addition to the separation and exit costs associated with 2012 Strategic Realignment, a $2 million charge was recorded in reorganization of business and other related to indemnification provisions included in Gregg Lowe's (our current president and CEO) employment agreement. Reorganization of Business Program
In 2008, we began executing a series of restructuring initiatives under the Reorganization of Business Program that streamlined our cost structure and re-directed some research and development investments into expected growth markets. The only remaining actions relating to the Reorganization of Business Program are the disposal or sale of the land and buildings located in Sendai, Japan and the decommissioning of the land and buildings at our Toulouse, France manufacturing facility, along with payment of the remaining separation costs. The following table displays a roll-forward from January 1, 2013 to March 29, 2013 of the employee separation accruals established related to the Reorganization of Business Program:

                             Accruals at                 Adjustments &                  Accruals
(in millions, except          January 1,                    Currency                    at March
headcount)                       2013        Charges         Impact          Used       29, 2013
Employee Separation Costs
Supply chain                         77            -            (2 )            (8 )         67
Selling, general and
administrative                        2            -             -               -            2
Research and development              2            -             -               -            2
Total                                81            -            (2 )            (8 )         71
Related headcount                   520            -             -             (20 )        500

The $8 million used reflects cash payments made to employees separated as part of the Reorganization of Business Program during the first quarter of 2013. We have adjusted our anticipated future severance payments by $2 million to incorporate the currency impact in the above presentation. This adjustment reflects the strengthening of the U.S. dollar against the Euro during the first quarter of 2013. The accrual of $71 million at March 29, 2013 reflects the estimated liability to be paid to the remaining 500 employees through 2014 based on current exchange rates.
Disposition Activities
During the first quarter of 2013 and in connection with the closure of the Toulouse, France manufacturing facility which occurred during 2012, we recorded a benefit of $13 million related to proceeds received for the sale of certain of our equipment and machinery located at this facility, which was partially offset by a $3 million charge related to on-going closure and decommissioning costs.


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Three Months Ended March 30, 2012 . . .

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