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FSL > SEC Filings for FSL > Form 10-Q on 26-Jul-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-Jul-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 and six months ended June 28, 2013 and June 29, 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 connectivity 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 19% of our total net sales in both the second quarter and first half of 2013. 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 22% and 21% of our total net sales in the second quarter and first half of 2013, 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% of our total net sales in both the second quarter and first half of 2013. 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% of our total net sales in both the second quarter and first half of 2013. 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 8% of our total net sales in both the second quarter and first half of 2013. 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. 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.
Our revenues increased 6% and our gross margin increased 190 basis points in the second quarter of 2013 as compared to the first quarter of 2013. The sequential increase in gross margin is attributable to an increase in front-end wafer manufacturing facility utilization from 79% during the first quarter of 2013 to 86% during the second quarter of 2013, operational efficiencies and higher revenues. These benefits were offset by product sales mix. During the second quarter of 2013, our backlog and order trends have improved as compared to the prior quarter, and our distribution sales increased 14% compared to the first quarter of 2013. The increase in revenue was driven by strength in our target markets including the automotive, industrial, networking and consumer markets.


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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. We anticipate our total net sales and profitability for the third quarter of 2013 to improve on a sequential basis due in part to continued strength for MCUs and applications processors sold into the industrial and consumer markets. For more information on trends and other factors affecting our business, refer to Part I, Item 1A "Risk Factors" in our Annual Report.
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, we incurred approximately $40 million of employee termination and exit costs along with other non-cash charges in 2012. 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 have completed the majority of the actions as of the end of the second quarter of 2013 and expect to realize the majority of the annualized savings of $35 million to $40 million by the end of the third quarter of 2013. The resulting savings achieved are being invested in research and development programs and other initiatives associated with our strategic realignment.
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. 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 $35 million, including $30 million in cash severance costs and $5 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, 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. The only remaining action to finalize the exit from this facility is the sale 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 rest 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 half of 2013, Freescale Inc. completed two refinancing transactions, which, among other things, (i) reduced the principal amount of indebtedness 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, (iii) reduced the principal amount of indebtedness due in 2018 by refinancing with notes due in 2021 and (iv) will reduce our cash interest expense by approximately $15 million annually based on current interest rates. (Refer to "Liquidity and Capital Resources - Financing Activities" below for additional discussion of transactions referenced in this section.)
On July 8, 2013, Freescale Inc. delivered notice to the holders of the senior unsecured 8.875% notes due 2014 that it will redeem the remaining $98 million of principal outstanding on the redemption date of August 7, 2013.


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Results of Operations for the Three and Six Months Ended June 28, 2013 and

June 29, 2012
                                                 Three Months Ended             Six Months Ended
                                              June 28,        June 29,       June 28,       June 29,
(in millions)                                   2013            2012           2013           2012
Orders (unaudited)                          $    1,094      $    1,009     $    2,084     $    2,008
Net sales                                   $    1,038      $    1,029     $    2,019     $    1,979
Cost of sales                                      597             589          1,180          1,137
Gross margin                                       441             440            839            842
Selling, general and administrative                115             116            226            218
Research and development                           187             188            369            369
Amortization expense for acquired
intangible assets                                    4               4              7              7
Reorganization of business and other                10              20              8            (32 )
Operating earnings                                 125             112            229            280
Loss on extinguishment or modification of
long-term debt, net                                (59 )             -            (81 )          (28 )
Other expense, net                                (125 )          (135 )         (245 )         (270 )
Loss before income taxes                           (59 )           (23 )          (97 )          (18 )
Income tax expense                                   6              11             16             25
Net loss                                    $      (65 )    $      (34 )   $     (113 )   $      (43 )



Percentage of Net Sales
                                               Three Months Ended           Six Months Ended
                                             June 28,       June 29,     June 28,      June 29,
                                               2013           2012         2013          2012
Orders (unaudited)                             105.4 %         98.1 %      103.2 %       101.5 %
Net sales                                      100.0 %        100.0 %      100.0 %       100.0 %
Cost of sales                                   57.5 %         57.2 %       58.4 %        57.5 %
Gross margin                                    42.5 %         42.8 %       41.6 %        42.5 %
Selling, general and administrative             11.1 %         11.3 %       11.2 %        11.0 %
Research and development                        18.0 %         18.3 %       18.3 %        18.6 %
Amortization expense for acquired
intangible assets                                0.4 %          0.4 %        0.4 %         0.4 %
Reorganization of business and other             1.0 %          1.9 %        0.4 %           *
Operating earnings                              12.0 %         10.9 %       11.3 %        14.1 %
Loss on extinguishment or modification of
long-term debt, net                                *              - %          *             *
Other expense, net                                 *              *            *             *
Loss before income taxes                           *              *            *             *
Income tax expense                               0.6 %          1.1 %        0.8 %         1.3 %
Net loss                                           *              *            *             *


* Not meaningful.

Three and Six Months Ended June 28, 2013 Compared to Three and Six Months Ended June 29, 2012
Net Sales
Our net sales increased by $9 million, or 1%, in the second quarter of 2013 compared to the second quarter of 2012 and by $40 million, or 2%, in the first half of 2013 compared to the first half of 2012. This sales growth was partially offset by declines in sales of legacy products into the cellular market. Orders increased by 8% in the second quarter of 2013 compared to the second quarter of 2012 and by 4% in the first half of 2013 compared to the first half of 2012. Distribution sales were approximately 26% and 25% of net sales in the second quarter and first half of 2013, respectively, and represented an increase of 16% and 9%, respectively, compared to the prior year periods. Distribution inventory, in dollars, was 9.1 weeks at June 28,


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2013, compared to 9.7 weeks at December 31, 2012 and 9.6 weeks at June 29, 2012. The decrease in weeks of distribution inventory, as compared to the prior year, was due to our distributors continuing to closely manage their inventory levels. Net sales by product group for the three and six months ended June 28, 2013 and June 29, 2012 were as follows:

                           Three Months Ended             Six Months Ended
                         June 28,        June 29,      June 28,      June 29,
(in millions)              2013            2012          2013          2012
Microcontrollers     $      199         $      169    $      376    $      318
Digital Networking          229                220           431           431
Automotive MCUs             272                258           526           498
Analog & Sensors            188                190           365           367
RF                           81                 66           167           133
Other                        69                126           154           232
Total net sales      $    1,038         $    1,029    $    2,019    $    1,979

Microcontrollers
Microcontrollers' net sales increased by $30 million, or 18%, in the second quarter of 2013 and by $58 million, or 18%, in the first half of 2013 compared to the prior year periods. The increase was driven by higher distribution sales in Asia and the Americas for the industrial and consumer markets and higher sales of application processors sold into the consumer and automotive markets. Digital Networking
Digital Networking's net sales increased by $9 million, or 4%, in the second quarter of 2013 compared to the second quarter of 2012. Growth from the second quarter of 2012 to the second quarter of 2013 was driven by broad based strength in our digital networking product portfolio across a majority of major end market segments (service provider and enterprise). Particular strength was observed in wireless infrastructure products supporting WCDMA, TD-SCDMA and LTE standards.
Digital Networking's net sales were flat in the first half of 2013 compared to the the first half of 2012 as growth in capital expenditures in wireless infrastructure was offset by lower sales as a result of some customers going through inventory corrections over the first half of 2012. Automotive MCUs
Automotive MCUs' net sales increased by $14 million, or 5% in the second quarter of 2013, and by $28 million, or 6%, in the first half of 2013 compared to the prior year periods. We experienced increased revenue primarily from sales in the US and Asia. The growth was driven by the positive vehicle production and sales trends in these regions, while the European market continues to be below historical levels.
Analog and Sensors
Analog and Sensors' net sales decreased $2 million, or 1%, during both the second quarter and first half of 2013 compared to the prior year periods. Approximately 85% of our Analog and Sensors sales are into the automotive market. Total sales into the automotive market were down for both comparative periods related to end of life shipments in 2012 in connection with the closure of our Toulouse, France manufacturing facility.
RF
RF's net sales increased by $15 million, or 23%, in the second quarter of 2013 and by $34 million, or 26%, in the first half of 2013 compared to the prior year periods. The increase was driven by growth in wireless basestation investments in China.
Other
Other net sales decreased by $57 million, or 45%, in the second quarter of 2013 compared to the second quarter of 2012 and by $78 million, or 34%, in the first half of 2013 compared to the first half of 2012. These declines were largely due to decreases in cellular product sales for both comparable periods. Lower intellectual property revenues also


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contributed to the decrease from the second quarter of 2013 as compared to the second quarter of 2012. As a percentage of net sales, intellectual property revenue was 5% and 7% for the second quarter of 2013 and 2012, respectively, and was 5% for both the first half of 2013 and 2012. Gross Margin
As a percentage of net sales, gross margin in the second quarter of 2013 was 42.5%, reflecting a decrease of 30 basis points compared to the second quarter of 2012. In the first half of 2013, as a percentage of net sales, gross margin was 41.6%, reflecting a decrease of 90 basis points compared to the first half of 2012. The decline in gross margin as a percentage of net sales for both periods 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, declines in intellectual property revenue along with changes in product sales mix. Partially offsetting these declines was an increase in utilization of our front-end manufacturing assets which contributed to improvements in operating leverage of our fixed manufacturing costs. Front-end wafer manufacturing facility utilization improved from 76% during the second quarter of 2012 to 86% during the second quarter of 2013 and from 78% during the first half of 2012 to 83% during the first half of 2013. Additional factors benefiting gross margin included procurement savings and operational efficiencies for both periods.
Selling, General and Administrative
Our selling, general and administrative expenses decreased by $1 million, or 0.9%, in the second quarter of 2013 compared to the prior year quarter. This decrease was primarily the result of lower marketing spending along with the favorable impact of the dollar appreciating against the currencies in which we incur substantial selling, general and administrative expenditures. These declines were partially offset by higher incentive compensation during the second quarter of 2013 and commitments for charitable contributions to the Freescale Foundation, a nonprofit, 501(c)(3) organization we established to support science, technology, engineering and math (STEM) education initiatives. As a percentage of net sales, our selling, general and administrative expenses were 11.1% in the second quarter of 2013, reflecting a decrease of 0.2 percentage points compared to the second quarter of 2012.
Our selling, general and administrative expenses increased by $8 million, or 3.7%, in the first half of 2013 compared to the prior year period. This increase was primarily the result of higher incentive compensation during the first half of 2013 and commitments for charitable contributions to the Freescale Foundation, partially offset by lower marketing spending in the first half of 2013. As a percentage of net sales, our selling, general and administrative expenses were 11.2% in the first half of 2013, reflecting an increase of 0.2 percentage points compared to the first half of 2012. Research and Development
Our research and development expense decreased by $1 million, or 0.5%, in the second quarter of 2013 compared to the prior year quarter and remained flat during the first half of 2013 compared to the prior year period. The cost savings as a result 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 18.0% and 18.3% in the second quarter and first half of 2013, respectively, reflecting decreases of 0.3 percentage points compared to both the second quarter and first half of 2012. Amortization Expense for Acquired Intangible Assets Amortization expense for acquired intangible assets related to tradenames/trademarks remained flat in the second quarter and first half of 2013 compared to the prior year periods as these intangible assets have reached a normalized amortization run rate.
Reorganization of Business and Other
In the second quarter of 2013, we recorded $9 million in charges related to continued implementation of the 2012 Strategic Realignment plan, primarily comprised of costs associated with consolidating workspace in Israel and Austin, Texas along with additional compensation for employees who were deemed crucial to the continuing implementation of the plan. Additionally, we recorded a $1 million charge related to on-going closure and decommissioning costs for the Toulouse, France manufacturing facility.
Additionally, during the first half 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. We also recorded $8 million of charges related to (i) continued implementation of the restructuring plan initiated in the fourth quarter of 2012, (ii)


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exit costs for underutilized office space and (iii) charges related to indemnification provisions included in our current CEO's employment agreement. In the second quarter of 2012, we recorded a charge of $21 million in connection with the change in the executive leadership of the Company. We also recorded $2 million in exit costs related to the termination of various supply agreements in connection with the closure of our Toulouse, France manufacturing facility along with $1 million of on-going closure costs due to inactivity at our Sendai, Japan fabrication facility. These charges were partially offset by a benefit of $4 million related to the expiration of indemnification obligations under a contract previously executed outside the ordinary course of business. Additionally, during the first half 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 second quarter of 2013, we recorded a charge of $59 million in the accompanying Condensed Consolidated Statement of Operations associated with the Q2 2013 Debt Refinancing Transaction, which included the extinguishment of existing debt and the issuance of the 5.00% Secured Notes. Additionally, during the first half 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 half of 2012, we recorded a charge of $28 million in the accompanying Condensed Consolidated Statement of Operations associated with the refinancing transaction in the first quarter of 2012, 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 second quarter of 2013 and 2012 included interest expense of $126 million and $128 million, respectively, partially offset by interest income of $1 million and $3 million, respectively.
Net interest expense in the first half of 2013 and 2012 included interest expense of $248 million and $263 million, respectively, partially offset by interest income of $2 million and $5 million, respectively. 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 of long-term debt during the second half of 2012.
Income Tax Expense
For the second quarter of 2013, we recorded an income tax provision of $6 million, predominately related to our foreign operations, which included a $1 million tax benefit associated with discrete events related primarily to the reversal of tax liabilities offset by withholding tax on intellectual property royalties. For the second quarter of 2012, we recorded an income tax provision of $11 million, which included a $2 million tax expense associated with discrete events primarily related to withholding tax on intellectual property royalties. For the first half of 2013, we recorded an income tax provision of $16 million, which included a net income tax benefit of $1 million primarily attributable to discrete events recorded in the second quarter. For the first half of 2012, we recorded an income tax provision of $25 million, which included a $6 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 . . .

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