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Freescale Semiconductor Inc. (FSL)

February 12, 2013 6:20 pm ET

Executives

Gregg A. Lowe - Chief Executive Officer, President and Director

Mitchell Haws

Analysts

James Covello - Goldman Sachs Group Inc., Research Division

James Covello - Goldman Sachs Group Inc., Research Division

Thanks so much for joining us for the session with Freescale. We have Gregg Lowe and Mitch Haws from Freescale joining us this afternoon. Guys, thank you so much for taking the time to do this.

Gregg A. Lowe

Thanks a lot for having us.

James Covello - Goldman Sachs Group Inc., Research Division

Terrific, terrific. A lot to cover. Gregg, I would love to start off, sort of big picture and have you talk a little bit about -- you've been at the company, I think you just took over CEO little over 6 months ago, if I'm not mistaken. And talk a little bit about what you saw when you got there, what you see today and the changes you've implemented and where we're going to go from here. So kind of big picture to start and then we'll kind of go down from there.

Gregg A. Lowe

Great. Thanks. Thanks a lot, Jim. And so I joined the company in June of last year. And the initial focus of my first couple of months there was really to look at the company and do kind of a strategic analysis of the company, and really, try to get to the bottom of how do we get this company growing and gaining market share again and how do we get an expanding gross margins. So those were the 2 primary focus areas that we were going through. We did an analysis with the entire team. I met with customers, I met with employees, I met with leadership and various different folks in the organization and spent that time basically analyzing all of the businesses at Freescale and asking 4 fundamental questions: What's our differentiation? To what markets can we apply that? What are the dynamics of those markets? And can we win? And it's obviously a lot deeper than that. But -- and then, we went through that analysis and in the third quarter -- at the end of the third quarter, we announced that the focus of the company was to focus into 5 primary areas. And now we're in the process of shifting our energy, our efforts, our R&D dollars into those areas.

So as an example of those 5 areas, so Microcontrollers, Automotive, RF and so forth, they had about 69% of our R&D spend. And our objective is to get it to 90% by the year 2015. Already in the first quarter of this year, we're in the low 80s and I actually anticipate that we'll probably leave 2013 already achieving that 90%. So we're rapidly moving our R&D into those areas. So I guess, what I would summarize is, I would say what I think I found was a company that had a lot of great capability, but was not really focused. We've now focused the company into some areas. I think that's going to help us grow our top line business or our top line revenue and increase the margins.

James Covello - Goldman Sachs Group Inc., Research Division

Now for people who don't know, you did a great job running Texas Instruments' analog business. It was the biggest analog company, you ran it, it was a terrific job, and you took this job, which was a company at the time that was struggling. And you took it right away. It was, I think, you were the first person the company went out to, and you took the job. What was it that you saw that caused you to leave a great organization where you are running the biggest company by a factor of 2, and come to this company that had been struggling at the time?

Gregg A. Lowe

Well, TI is a good place. It remains a great place. It's got tremendous people, a tremendous heritage, an unbelievable ethic both from a regular ethic plus work ethic standpoint, great people and TI continues to be that way.

I think when I looked at Freescale, I saw a lot of the same characteristics, where you've got a tremendous heritage, the Motorola heritage of Freescale. This is a company that once was very dominant. I see an engineering culture that I'm used to and I like, and I get excited. To be honest with you, I'm part nerd a little bit. So it's good to see an engineering culture as well. But I also saw a company that's been struggling for the last year, a number of years. And I translated that into an opportunity for me to help make a personal impact on this company. And so, I just saw it as an opportunity to take some great capability and that once -- it was a dominant force in the industry, and help it become a winning company again. I think, since I've been at the company, all of my initial observations are just amplified. There's people that have been there for 20 years. They've been through a lot of positive, a lot of negative. And what they want in life is they want to be able to drive in to work knowing that what they do today is going to make a difference and that's what we're helping them to do.

James Covello - Goldman Sachs Group Inc., Research Division

Now in various meetings that we've had since you've become CEO, you've been very granular in some of the changes that you've make. And I think in those sessions, it's really helped investors to walk away understanding some of the very concrete changes you've made. One that you've gone through, that I know had made an impact on investors before is what you did with the Power Management IC, the PMIC development. Maybe you could offer that as a very specific example of how you're changing the culture and strategy of the company?

Gregg A. Lowe

Well, we -- the company headed down a path of developing Power Management ICs, general purpose PMICs, if you will, for our, as an example, our application processor business. And this makes strategic sense in that it's nice to have a Power Management IC next to your processor. The downside of it is, we weren't that great at it. And there are other power management companies that are professional power management companies. They know what they're doing, and these are companies that largely don't have processors like we do. So instead of us trying to fight that fight ourselves and try to create a power management business ourselves, we, instead, have deemphasized that business and are working together with a couple of companies in the United States, a company in Europe and a company in Japan, to build out a power management portfolio. These guys are focused on power management, they know what they're doing. We've already gotten meetings together with them. They're some activities that we are already progressing in that -- down that path. And I think for our customers, it'll mean better combinations of solutions. We'll have the best processor. We'll also be able to offer vis-a-vis these partners the best Power Management IC. So it's a win-win, I think, for both companies. And I think it allows us to take our R&D resources and focus them back on that -- on the microcontrollers and the processors.

James Covello - Goldman Sachs Group Inc., Research Division

Another concrete example you had given us in one of the meetings is what you did, taking back-office-sales support people and turning that into salespeople on the ground, particularly in Asia. If you could elaborate on that a little bit?

Gregg A. Lowe

So we've increased our sales headcount or we plan to increase our sales headcount this year by somewhere around the order of 100 people. That's a relatively sizeable increase in feet on the streets, and yet, overall lowered our SG&A. And we've done that by taking back-office support, obviously, down and increasing the focus of having people call directly on accounts. The vast majority of that increase will be focused on China, where I think, we have a tremendous footprint from a technical standpoint. But I think we're a little bit behind in where we need to be from a sales standpoint. We're now measuring our progress on that throughout this year. I think the progress that we've already made in just a short amount of time from when we made that announcement in the end of October until now has been very impressive. We've opened up a couple of new offices already in China. We'll have 10 new office opened up by the end of this year. We'll have something on the order of about 70, 75 new people calling on accounts in China by the end of the year. We've made good progress on that. And that allows us to call on more customers. We anticipate that already here in the first quarter, we'll have increased our direct customer coverage by 150 people just in the first quarter alone. So real good progress there. I think, obviously, this is something that which is a much more of a long-term bet. But I think the thing that's remarkable to me is the most difficult thing to get in China, I think, is really the solid base of technical capability. And we've got hundreds and hundreds of designers and app engineers and so forth spread around a couple of different cities in China where people have had 15, 20, 25 years of experience with Freescale and Motorola. So it's something that I think is kind of an untapped capability.

James Covello - Goldman Sachs Group Inc., Research Division

You've been very careful about cautioning investors, look, this is going to take a little while to turn around some of the shares situation. So I have that on one hand. On the other hand, you guys just had an earnings report where you beat and raised your numbers and frankly, are seeing some of the improving trends in the industry, at least commensurate with everybody else and in some cases, a little bit ahead of everybody else and more so than everybody else. How should we reconcile those things?

Gregg A. Lowe

Well, I think it -- the incremental activities that we're doing in R&D spend and so forth, are going to have a gestation period associated with that in terms of turning it into revenue. We have Automotive customers, we have networking customers. This isn't the consumer market. That being said, we're not starting from a standing stop. So there's -- Rich and the team have done a great job of driving design wins and so forth. So we're trying to capitalize on that as best we can. We did come in at the high end of our guidance in Q4. And we did raise the expectation for Q1 and that was really great. But I would remind everybody that last year, we were down 14% overall. The market was down -- it will be down 3% to 5% depending on where the numbers finally come in. So the way I talk to our organization about this is it's not time to slam the ball down in the end zone. We are coming off a relatively easy compare. We need to stay sober about that and just understand that we've got a real job to do ahead of us.

James Covello - Goldman Sachs Group Inc., Research Division

Have we seen the worst of the underperformance because of the issues that you inherited behind us?

Gregg A. Lowe

I would say that we've got a lot of good positive momentum. I think the team is attacking the 2 objectives that we have. Top line growth, we've got the entire company focused on that. Salespeople are focused on that from an incentive standpoint. Bonus plans are all associated with that as well. And then same thing with margin expansion. So top line growth, margin expansion are the 2 things we're focused on. I believe that our ability to move the needle on top line will take a longer period of time because of the design end cycles and so forth. And I believe that our ability to move the needle on the gross margins will come in probably earlier than that because there are things that we can do to reduce our cost that don't require much change from a design standpoint.

So lot of opportunity there. I think the real key on that is focus. And what we've done is we now have 5 businesses across the company. Each of the 5 businesses have met with the manufacturing team and have given the manufacturing team a list of 5 things that they would like the manufacturing team to be able to accomplish to lower our cost. The manufacturing team has subsequently given each of the 5 businesses a list of 5 things that they could do, that would lower our cost or increase yields or what have you. The teams then get together. They look at that list of 10. They narrow it down to 5 that they're going to go work on, and it's called our 5 by 5 program. So 5 businesses have 5 things that they jointly agree to go accomplish with the manufacturing guys that will reduce our cost. This includes things like increasing yields. It includes things like converting from gold to copper bond wires and things like that. These are things that are real cost dollars that we think will have an impact. We have a weekly meeting on those and we're measuring the progress on a monthly basis. So a lot of intense activity associated with that. But I think the beauty of 5 by 5 is it's a focused set of 5 things that the businesses are working on. I think if we went after 100 different things, we'd end up doing 98 of them half right, and we really wouldn't get much progress there.

James Covello - Goldman Sachs Group Inc., Research Division

Your competitors love to talk about you guys as a share donor. It feels like half the meetings we walk into that, that's what people are saying. Obviously, you've said that there are share headwinds going forward. Yet again, whether it's in the networking business where you saw some things this quarter that maybe others didn't see, even some who claim to be taking share and -- or just the overall business. What's your view on what your competitors have to say about that? And then how long that, that's going to continue to be an issue?

Gregg A. Lowe

Well, I think the truth of the matter is the company's lost share in 9 of the last 10 years and I think that's just the truth. And obviously, that's something we're trying to change. And we've got a lot of actions in place to try to drive that. The way I think about it is the incremental activities that we're putting in right now are really going to begin see some impact probably in 2014, really in 2015. But again, we're not starting from a standing stop. I think at the end of the day, the best way to look at this is we're going to have a relatively -- we're going to have a very transparent view for all of our investors as to how we're doing on revenue. We're going to give you the revenue of each of the different businesses. And now that, as an example, the Digital Networking business is an operation that you'll see, you could just measure how we did versus the competitors and that'll be the easiest way. I think when we aggregate that one up as an example, I think we're down about 8% year-on-year. The list of competitors were down about 9%. So give or take margins of error, I would say there's relatively a tie in terms of pretty much holding share.

James Covello - Goldman Sachs Group Inc., Research Division

Now you talked about the 5 different businesses that you've reorganized the company into. How synergistic are those businesses? Did you need all 5? Could some of them be divested or one of them be divested over time if necessary from a balance sheet perspective? Or just strategic perspective?

Gregg A. Lowe

Yes, the way I think about this is really simple. These are all businesses that we own. We're focused on these businesses. We're attempting to make them better by increasing the top line and gaining market share and increasing gross margin. And that's really the focus of our energies and I think it's really important for us to attack those 2 things.

James Covello - Goldman Sachs Group Inc., Research Division

So if we could move a little bit into the product areas then when we talk about that and then kind of you've touched on all of them on some level but drill down into each of them a little bit more. Microcontroller, obviously, is an area of focus. What is your specific share goal within Microcontroller? And what do you think you need to do to differentiate yourself to get that share?

Gregg A. Lowe

Well, a couple of different things. First off, we have an Automotive Microcontroller business and we have a general-purpose Microcontroller business. And we've separated those 2 out and we have very clear objectives for those. The way we historically have been running this is we've taken our Automotive business and had that kind of as the lead horse in the race and then we would spin out parts for the nonautomotive customers. And that had 2 effects that I think were not positive: One is that the gestation period for Automotive was so long, by the time you're spinning something out, you've sort of missed -- the boat has sort of left the dock, if you will. And so, we were missing opportunities with industrial customers and so forth. And the second thing for the Automotive guys is since they were the lead horse, we were taking new process technologies, new memory technologies, new cores, and things like that and then trying to ramp those into Automotive customers, which has a high steep curve. So what we've done is we've flipped that around a little bit. I think that's going to be a benefit for both. Obviously, we'll have parts that's -- be faster time to market in general-purpose Microcontrollers. And we'll also have a higher quality of initial product ramp for the Automotive guys.

I think we've got a lot of nice design-in activity in our general-purpose Microcontroller. I think the products that have been announced recently, the Kinetis family of products. These are ARM-based microcontrollers that have unbelievably low power dissipation. By many measures, are the lowest dissipation in the industry of 32-bit. It's really turning a lot of heads. And I think the heritage that we have from a microcontroller standpoint, which means we not only have the know-how, but the intellectual property, the third-party tools, the software support, and so forth, combined with utilizing an instruction set architecture, the ARM platform that many customers are migrating to is generating a lot of positive buzz for that business.

James Covello - Goldman Sachs Group Inc., Research Division

Yes. Yes. And then just staying with the microcontroller business for a second and kind of switching back to the near term. One of your competitors in that space, probably yourselves and others have kind of taken incremental steps about some positive signs in the industry. One of your competitors in that space last week really kind of took the further step yet of anybody, really saying that they were seeing a very significant improvement. Do you have any reaction to what they were saying in that particular...

Gregg A. Lowe

No, Fantastic company that has a long heritage of delivering great results. And I have a ton of respect for them. So I think our job is to really focus on what we think we can do. I think the design-in activity is very, very strong. The products coming out are very strong. We're doubling down in this area. And I think eventually -- not eventually, but I think even as early as 2013, we'll see some good momentum there.

James Covello - Goldman Sachs Group Inc., Research Division

And their kind of view of the cycle, anything that you heard them say that was...

Gregg A. Lowe

As opposed to responding or reacting to Microchip, in this case, I guess what I would just say is our view of the cycle itself, and that is we saw a pretty nice progression in the fourth quarter, where we were just kind of getting better as the quarter progressed, which is a little counterintuitive. We saw that continue into the first quarter and so, therefore, we guided up in the first quarter and so forth. And I think that's really fine. I think the -- beyond that, there's limited visibility and the way we're playing it is very straightforward. We're keeping OpEx in control with the assumption that maybe it doesn't take off, yet at the same time, we're running factories at 71% utilization. So if it does take off, we obviously have the ability to absorb the incremental demand and benefit from it. So as I think, I've been in the industry long enough to finally have concluded that the ability to predict the industry is a little tough. So we'll just play it that way and try to have both ends of it play out.

James Covello - Goldman Sachs Group Inc., Research Division

We move on to the networking space then. Again we talked about it a little bit. But your guidance for the networking space, in particular, was better than a lot of folks in the industry. Is that the market? Is that your exposure? Is that share gain? Is it timing?

Gregg A. Lowe

Well, we'll see if it translates into share gain. But certainly, we see a little bit of a uplift in the first quarter. I think that the team has done a good job a number years ago of realizing that we needed to have a multicourse strategy. And so, I give the team a lot of credit for identifying that. And then getting the parts out, and now we're ramping multi-core products at 45-nanometer as we speak today. And so, we've got a competitive product in the market. I think that was gap in the portfolio a number of years ago I think that caused some share loss over the last couple of years. But now having that product out there, I think we should see some tailwinds there. I'm actually pretty encouraged with the 2013 outlook for the digital networking team.

James Covello - Goldman Sachs Group Inc., Research Division

And I've heard you reference the issue before around when you trace the share issues and networking back, it was really the maybe a delay or being too slow to go to dual core. I mean, that -- the postmortem on that, that's what you really think of the...

Gregg A. Lowe

Yes, and I think if you were to look in hindsight, you would say that was a mistake. But at the same time, this was a company that was a leader in this space and was leading basically by having single core and there was a lot of debate as to whether the software would be ready for dual core, and so forth, multi-core, and so forth. Obviously, the team made the wrong initial choice on that but did a correction, has products out in the market today. Market share remains above 50%. So it's a very strong position. And I think, having now products ramping that the customers are telling us are very competitive, is obviously a good thing.

James Covello - Goldman Sachs Group Inc., Research Division

Moving on to the Analog & Sensors piece of the business. In particular, the question around cross-selling, which I think is becoming a bigger and bigger question in the industry. What are the real cross-selling opportunities for Analog & Sensors vis-a-vis the other areas and how much of the bid is just a standalone business?

Gregg A. Lowe

Well, I think we haven't exploited those. Historically, the company has acted as several different independent entities for many years. And my understanding of the history when it was Motorola, is that actually were kind of independent entities with independent sales forces, and so forth. And so, there's a bit of trying to break that down.

I think the real key for us in that area is that business, and especially, the Analog business, I think is one where we've got a tremendous capability. We have the most difficult thing to get in analog, which is a large cadre of seasoned engineering talent, that's a really difficult thing find. As most of you know, analog talent is just really difficult to get a hold of. But I think the way we've been utilizing that talent has created a situation where we're underperforming where I think we can. So we bought a new guy in and to run the business. His name is James Bates. He comes from Maxim. And so, he spent 4 or 5 years at Maxim. He understands what analog businesses are before they got silicon labs. So here's a guy that comes in, has a really good sense for what analog is, was an analog designer at one time, and is now going through the portfolio, the products, the techniques, and so forth, and seeing a lot of just dramatic improvement capability that we can make, just by simply pointing a very capable team in a slightly different direction, design methodologies, test methodologies, things like that. So I'm really encouraged about the opportunity for us to improve that business. It's -- this is one where I think we have, obviously, with my background, when you see you've got the thing that's really difficult to get and just simply put new leadership in it, I think is -- will help point us in the right direction there.

James Covello - Goldman Sachs Group Inc., Research Division

And so you answered a little bit of this already. And I sorry, I think I can guess your answer, but of all the product areas we talked about, where do you see the best near-term momentum or most enthusiasm that you have for 2013, specifically? Is it that Digital Networking segment or the dual core processor?

Gregg A. Lowe

Well, I think the general-purpose Microcontroller business has got some good opportunities. I think our RF business, you saw we just turned in a 33% increase in revenue in the fourth quarter. That doesn't last forever but that's a sign of really good capability and good execution. I think, the Digital Networking business has got a great opportunity, I think, in 2013 to turn in some pretty good numbers as well. And then finally, with the Automotive business, looking stronger certainly in the United States, I think there's an opportunity for the Auto MCU [ph] guys to do well from a top line standpoint.

I think from a gross margin standpoint, I think our biggest opportunity is in the Analog business because you know where those kind of margins can eventually be and we're well below that. So I think the team's focused on that and it's doing a lot of actions to improve that.

James Covello - Goldman Sachs Group Inc., Research Division

And then on the gross margin, I think you guys have talked about the algorithm of 1-point utilization driving 30 basis points of gross margin improvement. So obviously, that's going to be cyclically dependent and you've been pretty clear about going to kind of take that as it comes in terms of the cycle. Beyond that, in terms of the gross margin improvement mix, obviously, will play a role on it and sounds like the Analog business is the area where you could see the biggest boost?

Gregg A. Lowe

I would say there's lots of different levers on the gross margin. One is, obviously, utilization. You talked about that and we're running right now -- well we ran last quarter at 71% which is pretty low. If we can see some incremental improvement in the top line, then you'll definitely see that increase as well. And that will obviously be a positive thing. These 5 by 5 programs that I had talked about are definite incremental improvements in gross margin. The mix is, obviously, something that can drive that as well. And I don't know if you want to add any comments to that, Mitch.

Mitchell Haws

Yes, Jim, if you recall, last time we peaked at around 11 50 or so of quarterly revenue. Gross margins at that point were in the 45% range. That was pre the benefit of the Toulouse savings. We start to roll through of the balance of this year. The procurement savings that we talked even as far back as the IPO. It's a multibillion-dollar spend for us. So constantly chipping away at that. Operational efficiencies, if you think about the way products yield, a lot of the operational things Gregg's talked about. I mean, when we talk about a 50% gross margin target over time, now that assumes much better utilization and a much stronger market. But those are the building blocks that you kind of foresee getting to something closer to 50%.

James Covello - Goldman Sachs Group Inc., Research Division

So on the theoretical 11 50 quarterly revenue number, you think you could be at 50%?

Mitchell Haws

I think as you can -- get back into that mid to high 40s over time, maybe a little bit of additional revenue growth. That's going to get you something closer to a 90% utilization, hopefully, in addition to the other operational benefits that we're talking about.

James Covello - Goldman Sachs Group Inc., Research Division

And is that as high as you feel comfortable running the fab -- running the fabs 90% or so before you worry about shortages and lead time stretching out too much?

Gregg A. Lowe

Well, yes and no. The other thing that -- so, yes, I guess is the direct answer. But I think we have an ability to increase the capabilities of our fabs with relatively low CapEx. And so, we think we can increase the output capability so that the utilization then would come back down with basically the same footprint. And David Reed, who's running manufacturing, is driving a whole bunch of action to do that and that's flows, standardization of test setups, things like that.

James Covello - Goldman Sachs Group Inc., Research Division

And the fab strategy, the mix of internal and external, how do you think about that?

Gregg A. Lowe

The strategy is really quite simple. At 90 nanometer and above, we'd basically produce most of our own stuff. There's a little bit of dual sourcing but at 90 nanometer and above, it's our own stuff. Below 90 nanometer, we outsource. We don't have any visions of having a 300 millimeter, 28 nanometer, $4-billion fab anytime soon. So that's not in the cards. So I think that's a relatively straightforward thing. And as the products start to migrate, the 65 nanometer and so forth, you'll see an increase in what we outsource just because of the mix. I would probably -- I would characterize it as, it'll be a slow and gradual change. I mean, a lot of the stuff we build in 90 nanometer and above is automotive, industrial, it's going to be here for a long time, and so forth. Analog and, as you're well aware, analog fabs, 90 nanometer is super leading edge. So we'll be able to utilize those assets for a long time.

James Covello - Goldman Sachs Group Inc., Research Division

Okay, great. If we can move over to the balance sheet. And I think it says volumes but we're 0.5 hour into the conversation and we're only now getting to the balance sheet. That's progress right, from 6 months ago. You did a -- maybe we start with the recent debt transaction you did to push outs some of the maturities and talk about that a little bit.

Gregg A. Lowe

Okay.

Mitchell Haws

So, Jim, what we did, is it falls on a series of other maturity extensions. The net effect of which means between now and 2018, about $750 million of debt comes due. So that's basically pushing everything to '18 and beyond. So what we got with that in some optionality in 5 years to figure out what are the best things to do now to start thinking about debt reduction and interest expense. So a lot of flexibility, what you would expect going forward as you get closer to 2014, our ability to look at some of the 18 and 20 tranches and refinance those at a better rate and capture the interest savings starts to make more sense. Candidly, you can do some of that today. The economics aren't particularly good because of the cost involved in prepaying some of the debt. It would be a significant premium. So we have the flexibility of a little bit of time here. We've taken a bunch of interest expense out. We've taken $3 billion of debt out. So with the maturity profile stretched out the way it is, now you can kind of save what is best. And as you get closer to '14, I think that would the first year you'd start to see meaningful reduction in interest expense, even if you don't reduce total debt.

In terms of other ways to reduce debt, at $3.7 billion of revenue, we're essentially cash flow breakeven. So dollars above that have a 60% fall through to gross margin, minimal CapEx. So to the extent, you start generating cash if you see revenues pick up. That's the first priority for cash flow generation is to repurchase debt.

Gregg A. Lowe

Yes, and again the metric that I've been communicating, 70%. I know you guys put ranges around it. But 70% of any revenue over $3.7 billion falls to cash flow. And so in a $5 billion revenue year, that's enough to repay even the maturities between now and 2018.

James Covello - Goldman Sachs Group Inc., Research Division

And when you think about what cash flows could be and what the interest expense could come to, what kind of picture can you paint relative to what an EPS number could look like in a more normalized environment?

Mitchell Haws

So if you look at the last 2 quarters of 2012, we took out 200 of the remaining 14 maturities. So that represented about $20 million of interest savings -- I'm sorry, $10 million for those 2. We did transactions earlier in the year to refinance portions of debt. The net result is we took about $40 million of annual interest expense out during the course of 2012. So that took you from 5 20 range to 4 80, 4 90, somewhere in that range, coming into this year.

The puts and takes for cash flow this year, you will see benefits to working capital as we continue to reduce inventory. You will see the benefit of fall through from incremental revenue. It will be a particularly heavy year in terms of severance. Most of the Toulouse severance, which we've accrued for, does start to flow out. The $40 million of operating savings that we announced in Q3, a lot of that payout and if you look at that $90 million to $100 million, it's spread over about the next 5 or 6 quarters. So if you compare cash flow generation this year to last, you get a pretty stiff headwind from severance.

That said, if you see a better environment, we are lower on CapEx. We don't have to increase CapEx to grow. So there is a lot of leverage for cash flow generation in the model if you see the market start to show some upward momentum.

James Covello - Goldman Sachs Group Inc., Research Division

And then recognizing most of the maturities now are pushed out to 2018 and beyond, so it really isn't a cash flow concern in terms of interest coverage, et cetera. What do you think the optimal capital structure is going forward? And how important is it from a customer relationship or investment standpoint to be able to get down to a lower net debt level?

Mitchell Haws

So when we did the deal in 2011, total leverage was in-force. Today, it's obviously, given that debt's gone down a little bit not a lot, EBITDA is a lot lower, you're probably looking at something 7, 8x. So clearly, 4 is a whole lot better than 8. But I think there are 2 questions you asked. Number one, if we can increase the EBITDA and continue to work the debt down, getting back to something like a 4 handle we think is a good kind of medium-term objective. From a customer point of view, it does require some amount of explanation to keep our customers comfortable. They've been extremely supportive of the move so far. If you go back to 2009, we have $3 billion less debt, $300 million less interest expense, and the maturity stack is completely moved to '18 and beyond. So they gave us a lot of credit. So it's a discussion I can -- I'm involved in most of those conversations. I can tell you, we've never lost a design because of it. Doesn't mean that there isn't some explanations and some work to do but we can get around that. We get a lot of credit for the work we've done on the [indiscernible]

Gregg A. Lowe

And I amplify that as well. I've met with lots of customers and they almost always start with, "It's a lot better than where it was. And obviously, the progress you're making is making us a lot more comfortable."

James Covello - Goldman Sachs Group Inc., Research Division

Listen, since we're not going to have a breakout, I did want to open it up to see if there are any questions in the room. You can just -- I'll repeat it if you...

Question-and-Answer Session

Unknown Analyst

Yes, you talked about a turnaround in your Networking business. My understanding is for that revenue recognition and for actual product shipment in that business, you would have had to have won incremental designs a year, possibly 2 or 3 years ago. You talked about that segment being up this year on a revenue basis or on the design basis? Or is the reason for the increase, is it just a macro return or reorder from your customer from existing designs? Or are you actually regaining a share in new design in particular. You lost a lot of share to Cisco over the last couple of years. Can you just give us some more insight on what you mean by turning around that business?

Gregg A. Lowe

Yes, I think that what I was referring to is actually, we're actually anticipating a revenue increase this year, which would be based on design wins that were won 2 years ago, which were based on the change in the multi-core that I had talked about. So I give the networking teams some credit -- a lot of credit for a lot of work that was done couple of years ago, to get that start to turn around.

Unknown Analyst

What about the [indiscernible] now on the level of design that you're seeing. [indiscernible] turn this business around. They did it 2 years ago. [indiscernible] I'm turning this business around now. So what are you doing in general [indiscernible] design wins now.

Gregg A. Lowe

Well, we've got a -- obviously, we track design wins for all of our different businesses, our Networking business, our Microcontroller business and so forth. I think the way that I think I'll talk about this is mostly, you got to see what be put up on the score board. What we're going put on the score board is real revenue. Because I think everybody can talk about design wins and so forth and there's a lot of sort of FUD about that. And I would just encourage you to look at what we do from a revenue standpoint this year, and measure us on that.

James Covello - Goldman Sachs Group Inc., Research Division

Maybe time for one more?

Unknown Analyst

In your recent refinancing, you mentioned that the term loan could be accelerated to 2017 maturity under specified circumstances. I wonder if you could give more color as to what those circumstances are? And also, talk about whether there are new covenant levels set with this. I mean, your 10-K says you're out of compliance with the ratios, but that doesn't matter. I just want a little color there too.

Mitchell Haws

So let's start with the ratio question and we'll kind of work backward. The deal was done in 2006. That was the nirvana of covenant life. So there are no maintenance covenants. The specific one that you're talking about would restrict payment of the dividend, certain other types of financings like that. So really, no practical import to being outside of the covenant. We would never pay a dividend given the current capital structure.

The second part of the question was about, I believe you're asking about the spring maturity feature, the '17s. That is a feature that if you're, I think, 4x levered or less, or $500 million of debt or less, that feature goes away. So it would pull the maturity into '17 assuming that you don't meet one of that -- of the 2 parts of that test. So I would expect between now and 2018, us to be able to manage that. If you think about 4x levered, we've been there once before and with some runway to look at refinancing for the next 5 years. But that feature does exist, but it's one we can manage around.

Unknown Analyst

[indiscernible]

Mitchell Haws

I believe it was -- I will verify it but I believe it's $500 million of debt and 4x lever.

James Covello - Goldman Sachs Group Inc., Research Division

Terrific. Well, guys, we used up the time. Thank you so much for being here. We appreciate and look forward to doing it again soon.

Gregg A. Lowe

Thank you. Appreciate it, Jim.

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Source: Freescale Semiconductor, Ltd. Presents at Goldman Sachs Technology & Internet Conference 2013, Feb-12-2013 03:20 PM
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