Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Freescale Semiconductor Ltd (NYSE:FSL)

Q2 2013 Earnings Call

July 25, 2013 5:00 pm ET

Executives

Mitch Haws

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

Alan Campbell - Chief Financial Officer and Senior Vice President

Analysts

John W. Pitzer - Crédit Suisse AG, Research Division

Ross Seymore - Deutsche Bank AG, Research Division

Gabriel Ho

Gabriela Borges - Goldman Sachs Group Inc., Research Division

Sujeeva De Silva - Topeka Capital Markets Inc., Research Division

William Stein - SunTrust Robinson Humphrey, Inc., Research Division

Rajvindra S. Gill - Needham & Company, LLC, Research Division

Glen Yeung - Citigroup Inc, Research Division

Stacy A. Rasgon - Sanford C. Bernstein & Co., LLC., Research Division

Doug Freedman - RBC Capital Markets, LLC, Research Division

Auguste P. Richard - Piper Jaffray Companies, Research Division

Jeffrey A. Harlib - Barclays Capital, Research Division

Tony Venturino

Operator

Welcome to Freescale's Second Quarter Results Conference Call. [Operator Instructions] Today's conference is being recorded. If you have any objections, please disconnect at this time. I would now like to turn the meeting over to Mr. Mitch Haws. Go ahead, sir. You may begin.

Mitch Haws

Thank you, Sharon, and welcome to each of you to our Second Quarter 2013 Earnings Conference Call. With me today are Gregg Lowe, our President and Chief Executive Officer; and Alan Campbell, our Chief Financial Officer. Before we begin the prepared remarks, please note that today's discussion contains forward-looking statements that are based on our current outlook. Therefore, they do include certain risks and uncertainties. Please refer to the cautionary statement in today's press release and review our 10-K and other SEC filings for more information on the risk factors that can cause our results to differ materially. The company does not assume an obligation to update any forward looking statements to reflect subsequent events or circumstances. In addition today, we will refer to certain non-GAAP financial measures. The reconciliations are on our website at freescale.com.

With that, let me turn the call to Gregg.

Gregg A. Lowe

Thanks, Mitch, and good afternoon, everyone. I'll spend a couple of minutes highlighting our Q2 results, and Alan will then provide additional commentary and insight into the financials and our outlook.

Now looking at the results. Revenues were $1.04 billion, coming in at the upper end of our guidance and up 6% from Q1. The improvement in revenue was broad-based, with 4 of the 5 product groups growing sequentially and 4 of the 5 year-over-year. We also continue to make progress in increasing gross margins and operating margins. Gross margins were 42.5%, 190 basis points ahead of Q1.

Adjusted net earnings per share were $0.09 per share, an improvement of $0.12 from Q1.

Overall, we made good progress in Q2 on both financials and on executing the strategic initiatives that are a foundation for our future growth.

I'll give some additional commentary on those initiatives after Alan reviews our Q2 results and our Q3 guidance.

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

Alan Campbell

Thanks, Gregg, and good afternoon, and thank you again for joining today's call. As I review the Q2 financial results in more detail, please note that I will be focusing on these results, excluding the impact of certain onetime items and adjustments. We believe this to be a more meaningful representation of our ongoing financial performance. As Gregg mentioned, revenues in the second quarter were $1.04 billion, representing a sequential increase of 6%. Sales grew 1% compared to Q2 of last year.

Looking at the product groups in more detail. Our microcontroller sales were $199 million in the second quarter, compared to $177 million in the first quarter of 2013, a growth of 12%. Compared to last year, Microcontroller sales were up 18%. Sequentially and year-over-year, sales benefited from increased sales in the distribution in Asia, as well as higher sales of application processors into the general embedded and automotive markets.

Digital Networking sales were $229 million. This compares to $202 million in the first quarter of 2013, representing a growth of 13%. Compared to last year, sales grew 4%. Networking sales benefit both sequentially and year-over-year from higher spending on current and next-generation wireless networks and higher sales of product used in enterprise solutions.

Automotive Microcontroller sales were $272 million, compared to $254 million in the first quarter, a growth of 7%. Compared to the second quarter of last year, sales were up 5%. Automotive Microcontroller sales benefited both sequentially and year-over-year from positive vehicle production and sales trends in the U.S. and China.

Analog & Sensor net sales were $188 million, compared to $177 million in the first quarter of 2013 and $190 million in the second quarter of last year. Our Analog & Sensor net sales benefited from a sequential increase from increases in global automotive production. The year-over-year comparison in revenue was impacted by higher shipments in 2012 associated with the closure of our Toulouse facility.

RF net sales were $81 million, compared to $86 million in the first quarter, a decline of 6%. Compared to Q2 of last year, RF sales were up 23%. The RF sales increased last year due to an increased spending on 3G and 4G wireless networks, particularly in China. The modest sequential decline was related to a product transition, which we expect will be completed over the second half of 2013.

Other net sales were $69 million. This compares to $85 million in the first quarter of 2013 and $126 million in the second quarter of last year. Both sequentially and year-over-year, other net sales declined due to lower sales in our wireless handset market and a decline in IP licensing revenue.

Finally, sales to distribution increased 14% sequentially and were up 16% compared to the same period last year. Distribution inventory was basically flat compared to Q1 and down compared to the same period last year.

Weeks of inventory were 9.1, compared to the 9.2 in the first quarter, and this compares to 9.7 weeks in the same period last year.

Our book-to-bill ratio in the second quarter was 1.05. All product groups were above 1.

Now looking at gross margins and operating expenses. Our gross margin were 42.5%. This compares to 40.6% in the first quarter. The gross margin has benefited sequentially from higher factory utilization, as well as operational efficiencies, offsetting the impact of IP revenues and product mix. Compared to last year, gross margins were down 30 basis points. Benefits were realized from factory utilization. Operational efficiencies and procurement were offset by a reduction in IP revenues.

Our internal front-end factory utilization was 86% in the second quarter. This compares to 79% in the first quarter and 83% in the same period last year.

Our operating expenses, as a percent of sales, slightly declined. Dollar expense, however, increased by $9 million sequentially due to a combination of variable compensation expense and an increased charge related to the creation of the STEM foundation.

Our operating expenses on a year-over-year basis were essentially flat.

Adjusted net earnings were $0.09. This compares to a loss of $0.03 in the first quarter. Our earnings per share benefited sequentially from higher revenues and improved gross margins. Adjusted earnings per share was $0.02 ahead of last year, primarily due to higher operating earnings.

EBITDA in the second quarter was $212 million, or 20% of sales. This compares to $178 million or 18% of sales in the first quarter and $202 million or 20% of sales for the same period last year.

Adjusted EBITDA was $802 million on a trailing 12-month basis.

Cash and cash equivalents were $785 million, compared to the $767 million in the first quarter. Cash benefited in the second quarter from higher profitability and improvements in working capital. We made progress again in the second quarter with working capital, which represented a $63 million source of cash in the quarter. This marks the sixth consecutive quarter of positive cash from working capital.

Inventory dollars declined by another $27 million sequentially and $83 million from the same period last year.

Inventory days were at 111. This compares favorably to the 118 in the first quarter and 125 days in the second quarter of last year. Excluding the inventory related to the Toulouse facility transition, inventory days were at 104.

Our capital expenditures for the quarter were $40 million or 4% of sales, consistent with our model of 3% to 5% over a cycle.

Looking to Q3, we would expect an increase in capital expenditures as we continue to make investments to support our growth initiatives. Given our consistent execution in managing cash, we continue to have solid liquidity.

Our cash and cash equivalents, coupled with our ongoing revolver of approximately $400 million, enables us to continue to invest in the business, fund our capital expenditures and to continue to delever.

We also continue to make improvements with our capital structure. In June, we refinanced approximately $450 million of our 2018 senior secured bonds with 2021 maturities. This will result in an annualized interest savings of approximately $20 million.

In addition, in early July, we announced there the redemption of approximately $100 million of our senior unsecured bonds with 2014 maturities. This will result in an additional $9 million of annualized interest expense reduction. This leaves us with about $670 million of maturities between now and 2018. We will continue to use cash to delever and be opportunistic in refinancing all our high-coupon debt.

Let me now take a few minutes to discuss the outlook for the third quarter. Based on the current outlook, we expect Q3 revenues to be in the range of $1.05 billion to $1.09 billion. By product group, we expect continued sequential improvement in our Microcontroller revenues, driven by improving trends in both general purpose MCUs and application processors.

Digital Networking revenues are expected to be modestly up in the third quarter, given continued growth in various enterprise markets.

Our Automotive Microcontrollers and our Analog & Sensor revenues are expected to be flat with the second quarter, which is ahead of the typical Q3 seasonality.

RF sales are expected to grow modestly from Q3 -- from Q2. And finally, other net sales are expected to be in line with the second quarter.

Finally, we expect factory utilizations to be relatively flat and gross margins to increase 75 to 100 basis points sequentially.

At this point, I'll turn the call back to Gregg.

Gregg A. Lowe

Thanks, Alan. While we're very early in the process as a team and still have a long way to go to reach our goals, we've made some decent progress. The business is starting to show signs of getting back on a growth trajectory. Part of this is certainly market-driven, but we're seeing new products ramp in many areas that are helping us outgrow the market.

We are improving profitability. We continue to improve our capital structure. In the past couple of months, we have reduced interest expense by $30 million on an annualized basis.

We've assembled a new management team that is executing well and is aligned with our goal of driving revenue growth and margin expansion. The realignment of our product groups is focusing our R&D in the right areas. Now recall, we had a target to get 90% of our R&D spend into these areas by the end of 2015. We'll actually be close to that goal by the end of this year, fully 2 years ahead of plan.

We are expanding our sales footprint with a special emphasis on China, and we'll open 10 new sales offices by year end. We're touching more customers, having already called on 500 new accounts this year.

We've started to reenergize the Freescale team. We are providing greater clarity on our company objectives with everyone focused on revenue growth and margin expansion. We're beginning to see tangible progress towards these goals as evidenced by the last few quarters' results, and this has resulted in Freescale beginning to pay bonuses again.

We are reengaging the communities where we operate. An example of this is the Freescale Foundation that Alan talked about, which is focused on STEM education. This effort is important to our community and to Freescale, as it helps to develop the future technology leaders at our company.

So good progress so far, but a lot more for us to achieve as a team. We look forward to sharing our success as we move forward. And at this point, we'll open the call for questions.

Mitch Haws

Karen, you can open up the call for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from John Pitzer of Crédit Suisse.

John W. Pitzer - Crédit Suisse AG, Research Division

My first question is on the gross margin improvement. From the September quarter, calling for 75 to 100 basis points on. I wonder if you can help me understand, to what extent is that utilization improvement you saw in the June quarter falling through versus mix and versus other things? And given that you expect utilization to be sort of flattish in the September quarter, from September level gross margins, how do we think about incremental improvements from there?

Alan Campbell

Yes, thanks, John. The gross margin, the guidance of 75 to 100 basis points will be predominantly coming from the operational efficiencies that we've talked about in the past. If you recall that we've mentioned really 4 building blocks, one was utilization, one was operating efficiency, one was procurement and one was kind of portfolio pricing. Utilization is expected to be relatively flat going into the third quarter. And we do expect to slightly reduce inventory compared to the $27 million we reduced in the second quarter. So most of the focus is centered around the operational efficiency. There will a slight benefit on the utilization, which will be related to some of the Toulouse closure. And -- but that's more looking into the third quarter. If we look at the margin -- the guidance, our expectation is still to get into the high 40s at the revenue rates we've discussed in the past. And that should be up in the 11 50 to 11 75 per quarter. And now they're materialized, there's a lot of effort and energy within the company around those 4 building blocks that we've talked about. So it's a nice drumbeat of continued sequential improvement.

John W. Pitzer - Crédit Suisse AG, Research Division

Great. And then for Gregg. Gregg, you mentioned in your opening comments you think that you're taking share and outgrowing the market. Maybe you can give us a little bit more detail on to which areas you're most confident about share gains on kind of a bottoms-up perspective and how we should think about continued share gains from here?

Gregg A. Lowe

Well, let me start, I think we've had a good start to the year, to the first half of the year. The first quarter and the second quarter were pretty good starts for us from a revenue perspective. But let me balance up by saying it's only 2 quarters. So again, a bit of a repeat of what I said, last quarter, we're not celebrating and saying that we're done. We've got a lot of work still to do. I think we've made some pretty good progress in a number of different areas. I think in the Digital Networking area, clearly, we've made some good progress on the top line, which I think is resulting in share gains that we had -- that we delivered in the first half of this year. I think all of the businesses are focused on the 2 things, the 2 priorities that we have as a company. That's revenue growth to gain share and increased margin to increase profitability. So I think everybody's chipping in on that. I think the networking guys probably stood out in the first part of the year. I think Microcontrollers had a pretty nice first half of the year as well.

Operator

Our next question comes from Ross Seymore of Deutsche Bank.

Ross Seymore - Deutsche Bank AG, Research Division

Gregg, somewhat similar question. As far as some of your longer-term metrics, it seems like your Microcontroller business has done quite well over the last 3 quarters on a year-over-year basis, especially. I know industrial is a relatively smaller part of your business than you might want it to be going forward, and you've invested in China infrastructure, et cetera. Can you walk us through some of the mile markers we might be able to watch to see how successful Freescale is in penetrating that industrial market?

Gregg A. Lowe

Sure. And I think the -- as we laid out the strategy at the end of last year, so sort of in the November time frame is when we laid out the strategy of focusing on the 5 businesses and so forth. We had said that there's going to be a sort of a gestation period for some of these activities to translate into the results that we want. Some will -- some markets will happen faster, some will happen a little bit slower. The automotive market is certainly one of the ones where as you start moving the needle, the -- from an activity standpoint, the results show up 3 to 5 years later. Industrial is, I think, in a sort of similar type vein. As we begin to penetrate and increase our attention in that market, we'll see design wins relatively soon and then translating it to revenue could be maybe 2 years later. So I think we've made some pretty good progress, but we still have a lot still to do.

Ross Seymore - Deutsche Bank AG, Research Division

Great. And I guess as a -- one little quick follow-up on that. Is following the distribution as a percentage of sales a fair metric to show that progression?

Gregg A. Lowe

I don't know about that. I think...

Alan Campbell

I don't think so. Distribution today is about 26% of sales and a lot depends on what we're doing with some of these OEMs. In some cases, we will directly ship to the OEMs, so it doesn't necessarily correlate with a metric of just measuring sales to distribution.

Ross Seymore - Deutsche Bank AG, Research Division

Got you. Then, I guess, this is my one true follow-up, one for you, Alan. How should we think about OpEx dollars going into the third quarter and then relating to revenues longer term? And then specifically, in the third and maybe fourth quarter, also the interest expense and how some of the paydowns of the debt and refi, et cetera, are going to flow through.

Alan Campbell

Yes. So on an operating expense basis, I think if you're thinking about 28% to 29% of sales, probably in the ballpark, which, based on guidance, would indicate relatively flat expenses going into the third quarter and the fourth quarter. In terms of interest charge, we have done quite a bit on the capital structure. We mentioned in the call 2 transactions resulting in $20 million of annualized savings and one resulting in $9 million. So we'd expect interest to fall into the third quarter into the $118 million type of range. And that kind of compares to the $125 million in the second quarter. So some nice sequential improvement expected in the third.

Operator

Our next question comes from Ambrish Srivastava of BMO.

Gabriel Ho

This is Gabriel Ho calling for Ambrish. I'm actually looking at your book-to-bill ratio. It's 1.05 and, if I do my math right, is $1.09 billion and then you guided 1.07 at the midpoint. What drives the conservatism? And can you also walk us through what -- how do you reconsolate [ph] that? And do you see extension lead time?

Alan Campbell

Yes. So first of all, lead times remain, for the most part, unchanged. From a book-to-bill ratio, we've seen book-to-bill consistently, actually, for the last 6 months being above 1. It's difficult to look at just our book-to-bill, particularly in the third quarter where there are some anomalies with the July and August months, which tend to be later in September higher. All in all, we are obviously comfortable with how the bookings and backlog are settling in relative to the guidance we've given.

Gabriel Ho

Okay. As follow-up now, can you remind us what is the seasonality for the Q4?

Alan Campbell

Seasonality, first of all, to the third quarter is probably 1% to 2%. And for the fourth quarter, it can be 0 to minus 1%, minus 2%. So it's difficult to measure seasonality too much. We've all seen that because we have such a diversified portfolio. Our networking business, for example, that's been characterized by first half, second half seasonalities, but generically, I would say, they're kind of 1% to 2% third quarter and 0 to 1%, 2% negative in the fourth quarter.

Operator

Our next question comes from Jim Covello of Goldman Sachs.

Gabriela Borges - Goldman Sachs Group Inc., Research Division

This is Gabriela Borges on behalf of Jim. I wanted to ask on trends in the Digital Networking segment. Could you comment a little more on what you're seeing into the back of the year in service provider vertical and in the traditional enterprise vertical? And if you can elaborate a little bit on the competitor environment as well given the earlier comments on China [ph], that will be very helpful.

Mitch Haws

Thank you, Gabriela. This is Mitch. If you look at the second quarter, I think if you look at the top 15 customers, we grew at 14 of the top 15, so very broad based. Revenue growth came from enterprise, came from service provider. The only kind of nuance, I think, is important in the service provider revenue, none of that was related to China. It was North America, other geographies outside of China. I think looking to the back half of the year, there's are still some pockets of enterprise where we see strength. We did guide that business up again into the third quarter. I think you're asking also specifically about China and LTE spending. We see the same news reports as everyone else. The targeted number of base stations and the timing and I think that it is likely to show some projection in the back half of the year. The question will be the precise timing. What percentage of the build-outs or software upgrades versus new equipment? So there's still some question marks in terms of the magnitude and the timing. The good news for us is we have good real estate in that market, both with our processor portfolio and with our amplifiers. So I think it's hard to be precise with the impact, but there likely is a concentration of activity in the back half, and I think we're well positioned there.

Gabriela Borges - Goldman Sachs Group Inc., Research Division

That's very helpful. And then as a follow-up, if I may, I was hoping you could give us some color on how we should think about the IP revenue going forward. Is there a long-term sustainable run rate that we should be thinking about? And how should we think about the quarter-to-quarter volatility?

Alan Campbell

Yes. So the IP revenue in kind of a shorter-term basis, in terms of the guidance we gave you [ph], was relatively flat from that of the second quarter. We have said in the past that IP can be, by the nature of it, somewhat lumpy. But going forward, I think the kind of $40 million per quarter is probably a reasonable expectation to be thinking about.

Operator

Our next question comes from Sujee De Silva of Topeka.

Sujeeva De Silva - Topeka Capital Markets Inc., Research Division

So first of all, on the communications side, you had a nice sequential growth in the second quarter and third quarter. You're guiding for modest growth. But there's some level of inventory correction there. You think we've seen that from other customers, same company, same sort of guidance. What did you guys see there?

Mitch Haws

Sujee, this is Mitch. I think the challenge there is that the composition of our revenue is so diverse, given that we've been at this business so long, and it's multiple customers all with a relatively modest percent of revenue. A change in one customer tends not to have a big impact. There probably was some of that inventory correction coming out of 2012, but if you look at the first, at least the first half of this year, it's been relatively linear demand through the quarter. I mentioned 14 of the top 15 customers grew. And even within enterprise, there are different pockets of growth. So it's no one customer, no one geography or no one program. So we benefit from adversity, and I think there probably was some of the inventory trends you're talking about last year. We haven't seen as much of that, at least in the first half of this year.

Gregg A. Lowe

Yes. And as an example, Alan had mentioned we have 25% of our revenue in distribution, and the inventory days and the channel went down slightly. And we have about 40% of our inventory in automotive -- I'm sorry, 40% of our business is in automotive. And if you look at dealer inventory, as an example in North America, exiting June, it was 66 days, which is well within the historical level.

Sujeeva De Silva - Topeka Capital Markets Inc., Research Division

Okay. And then a question for Alan perhaps. You were good enough to give a revenue and gross margin target when you get to that revenue level. Would you care to put out an operating margin target as well? And do you think you can keep OpEx flat as you get towards that target gross margin level?

Alan Campbell

Sujee, so in terms of kind of governance principle, we do give guidance on revenue and gross margin and give direction on OpEx. And it's fairly easy then to take the operating margins from that piece and what we get. So we believe the operating expenses will be relatively flat getting into the third quarter. So that should help build the model.

Operator

Our next question comes from William Stein of SunTrust.

William Stein - SunTrust Robinson Humphrey, Inc., Research Division

I'm wondering if you can help us -- or remind us about the revenue drawdown that relates to the Toulouse factory closure. When do we expect the results of that to play through the models so we start seeing the revenue stop declining and the better margins from that?

Alan Campbell

Good question. I think -- let me say first of all, from the financial impact on closure of the Toulouse facility, we have realized approximately 2/3 of that saving. So we've said historically that we should see $70 million of annualized savings and 2/3 of that has been realized, so 1/3 will still go. In terms of inventory step-down as a process, it's not a step function. We did see about 7 days of reduction associated with Toulouse. And as -- it does -- is a function, obviously, of products, markets, growth, et cetera. I would expect that we'd see some inventory reduction continue into the third quarter and fourth quarter as it relates to Toulouse.

William Stein - SunTrust Robinson Humphrey, Inc., Research Division

And then a follow-up, if I can. Two of the initiatives, the strategic initiatives, that you started have been, I think, to increase your reach in China. You talked about 10 new offices and also your use of distribution to expand that. Can you talk about how far through that process you are? Is that very early stages still? Or do we expect the progress on that to last for several quarters to come?

Gregg A. Lowe

Yes, we are definitely in the early stage of all of the initiatives. We're working very hard on all of them. There's a tremendous amount of focus. And I would say that focus spans now the 18,000 or so employees at the company. But we began this process -- we announced the process in -- at the end of October, beginning of November last year, we're just 8 months into it and so we still have a lot to go. I guess, what I would say is as you would -- as you had mentioned and as we have talked about, we've hit the ground running with the China sales force. We've increased the number of offices already. We'll have 10 open by the end of this year. We've increased the number of people there. We've moved experienced people from one city to the new offices so that we're -- we've got experienced employees working with customers. We reached out and touched 500 new customers with a lot of exciting opportunity with all of those customers, so I think the initiatives have been working very, very well, and we're working very hard on all of them so there's 100% effort on those. But I think we have -- this is going to be a multiyear journey where we just continue getting better and better and better.

Operator

Our next question comes from Raji Gill of Needham & Company.

Rajvindra S. Gill - Needham & Company, LLC, Research Division

Just a question on the Digital Networking business. It has been growing sequentially through the last 2 quarters, which the second quarter was kind of a big jump. And you talked a little bit about it before that, in the past, it was -- you're benefiting from some of the LTE deployments and enterprise as well. How should we look about your kind of -- look at your multi-core processor offering relative to the competition and your new product Layerscape? How has that product been tracking relative to the competition? And is that going to allow you to gain more market share in that specific segment?

Mitch Haws

Yes, good question, Raji. If you look at the progression of the 45-nanometer business, which, by definition, most of that would be a multi-core offering, we grew that portion of the business roughly 40% sequentially. On a year-on-year basis, probably closer to 60% or maybe a touch higher than that. So making very good progress. That's a key part of future design wins. Obviously, it's an initiative we launched in earnest back in the 2009, 2010 time frame. So part of what you're seeing in terms of momentum is clearly related to that offering and it's still, frankly, very good growth profile, but early innings for that product as well.

Rajvindra S. Gill - Needham & Company, LLC, Research Division

And Alan, maybe if you could just take a broader perspective on the cycle. We've had a slew of results coming from some of the companies. It seems to me things are picking up a little bit. If you could maybe talk a little bit about how you view -- what's your view of the overall cycle as in terms of what the demand trends are relative to, say, last year or the year before.

Alan Campbell

Yes, that's a very difficult question. There's many differing inputs on where we are in the cycle. But as we look out, we all know that semiconductor has historically been characterized by a V-shaped cycle, which has significant peaks and significant lows and the troughs. This cycle that we're going through at the moment is more of an L-shape. And with our L-shape, we do see much lower sequential volume in the kind of mid-single digits, and we expect that to continue. So as we see the cycle abutting any major changes in the macro, we would see this continued sequential-type improvement. Now again, there are many views and opinions on that, so one has to be careful. Maybe Gregg has also got an opinion on this one.

Gregg A. Lowe

Yes. And maybe it's just a couple of additional points because you were asking about the comparative 2011 and 2012. And 2011, obviously, was a very different year, primarily because of a -- the tragedy in Japan, unfortunately. That was 2011. 2012, it was impacted by basically demand and inventory overhang. I guess what I would say, here we are, we're in July right now. And if we compare ourselves to July 2012 and 2011, I guess the thing that's different is, by this time during those periods, book-to-bills were already heading below 1 and -- where we're at already below 1, and guidance for most semiconductor companies was relatively weak. So I think we've had a pretty good start to 2013. Certainly, from a Freescale perspective, we feel pretty good about it. And we've got a good start to Q3. So we're handling this stuff kind of quarter at a time, and we're trying to be prudent from an OpEx standpoint and prudent from an inventory standpoint, but at the same time, trying to maintain levels of serviceability, the service that our customers expect from us. So I think the -- I think things at this point are pointing a little bit north in Q3, and we're obviously preparing for that.

Rajvindra S. Gill - Needham & Company, LLC, Research Division

Great. And just one last question, if I can, Alan, on the debt. You talked about some recent refinancing. Could you talk a little bit about, just real quickly, the big tranche, the $1.38 billion that's due in 2018? I believe it's a senior secured at 9.25%. What are the plans for that?

Alan Campbell

We have, yes, $1.6 billion in 2018. There's some 10 1/8%, as well as 9 1/4% paper there. We continue to look at the economics of all of the maturities, and we'll continue to be active relative to the economics. So we did -- I think some of the 2018, we took out just less than $450 million and we were able to secure 5% paper for 2021. So I think, Raji, the best we are thinking about, we'll continue to be opportunistic and look at the economics.

Operator

Our next question comes from Glen Yeung of Citigroup.

Glen Yeung - Citigroup Inc, Research Division

First question, still sort of harping back on this OpEx issue, Alan, are there still things in OpEx that you can do to bring it down to offset what looks like a little more sales expense and some bonuses as well? And is that allowing you to keep the OpEx flat?

Alan Campbell

Well, yes. I mean, I think we feel actually that the OpEx is pretty competitive. Our SG&A is running about 11% and are around these at 17% to 18%. The increase in OpEx, as we mentioned, was a function of the improved operating performance, which is what we want in terms of paying more variable compensation as the business improves. And our expectation is that as the business improves, there will be more available compensation. There will be some slight offsets that we'll continue to tightly monitor our discretionary spend. And we've proven in the past that we can do that. We'll continue to look at that. But I think it's important as the business improves, we can continue to recognize that improvement via the variable compensation. But again, operating expense for the third quarter we've kind of guided, Glen, that it will be flat from that of the second.

Glen Yeung - Citigroup Inc, Research Division

And maybe just along those lines, Gregg. You came from a shop where the sales force was large and it was really a competitive advantage for them, and OpEx for sales there were slightly higher than what we'd see at Freescale. Do we think about that strategically? Do you think about that strategically for Freescale, that you want to build a big sales force that is kind of like what we've got?

Gregg A. Lowe

Our focus is on doing 2 things: one is driving top line revenue growth; and the second is improving gross margins. And we've got the 18,000 employees of the company all driving that. I think the expansion that we're talking about from a sales force perspective is primarily focused on an area where we think there's tremendous amount of growth potential and that's through China. And that activity is growing. I think we've made some pretty good progress on that. I think that's going to open up lots of new customers, lots of new opportunities. And the evidence there is the 500 new accounts that we're already calling on. So I think it's really that we're trying to do and not necessarily mimic anybody. We're really just trying to put then focus our resources in areas that are going to help us grow. We did the same thing from an R&D perspective. What we did from an R&D perspective is take the spend that we had and focus it into 5 specific areas. That dramatically increased the spend in those areas, while keeping our overall R&D spend in check. And so the way we did that, obviously, was decreasing spend in areas that we didn't think were going to grow the business. So that's really the way I'd characterize it, Glen, and what we're really trying to do.

Glen Yeung - Citigroup Inc, Research Division

Okay. That's helpful. Can I just sneak one more quick one? Which is it sounds like, based on your commentary, that Asian distributor sell-through was around 14% for the quarter. And it strikes me as a high number, given what we're seeing happening in the end markets, and I wonder if you could shed some light as to what exactly is driving that.

Alan Campbell

Well, we have a lot of product portfolios. One element is driving it. We've seen a nice uptick in momentum in the Microcontroller business with our Kinetis 32-bit ARM-based microcontroller. Again, a little bit -- revenues increased sequentially 14% and it's actually 16% annually. We are keeping an eye on inventories at the same time and inventories, as we see it, are still flat. So this is real demand and that is coming through with the product portfolio, Glen.

Operator

Our next question comes from Stacy Rasgon of Sanford Bernstein.

Stacy A. Rasgon - Sanford C. Bernstein & Co., LLC., Research Division

First, I had a question on the debt restructuring. So you paid off about $442 million of the 2018 10 1/8%. I think you still have about $220 million of that tranche left. And the new debt, you said that was 5%. Why didn't you refinance at least the whole tranche? Why not more? Was this a function of the premium that you had to pay cash due to refinance? Was this a function of, I guess, market acceptance of the offering? Or why not go bigger on this?

Alan Campbell

It was a function of both, Stacy. I think it was a function of market premiums. We do feel comfortable that, if we look at the $1.6 billion of 2018 maturities, that's about $220 million of 10 1/8% paper beyond the balances than 8 1/4% paper.

Stacy A. Rasgon - Sanford C. Bernstein & Co., LLC., Research Division

Got it. And you still feel comfortable, I guess, with $750 million as your kind of optimal cash level?

Alan Campbell

Yes, we do. I think, realistically, we said actually we've kind of lowered the bar. That we'd be happy even to go above -- to go to the $700 million type level. Our true operating performance is less than that, but we want to make sure those are significant buffers. So yes, we do feel comfortable with $700 million to $750 million.

Stacy A. Rasgon - Sanford C. Bernstein & Co., LLC., Research Division

That's helpful. And if I could ask one more. You had a pretty big utilization increase this quarter. Was any of that increase directly related to the closing of Toulouse? Or was it all increased loadings? And the reason I asked is, again, you had -- you're guiding utilizations kind of flat. You're taking inventories down, but your revenue growth -- I guess, that kind of utilization increase would seem to support a bigger revenue growth.

Alan Campbell

Yes, this is one that one has to look at, the utilization over a period of time. First of all, the utilization did increase from 79% to 86% in the second quarter. Despite our increase, we were still able to reduce some inventories by $27 million. The guidance we have given and we continue to monitor this very closely relative to the market conditions. The guidance we have given is that utilization will be relatively flat, and with that, we would expect inventories still slightly to move down. So I would say also that the utilization, as across the board, is not just related to Toulouse.

Stacy A. Rasgon - Sanford C. Bernstein & Co., LLC., Research Division

Got it. So some of that increase was because you took capacity off? Or is Toulouse already completely closed and not part of your active capacity?

Alan Campbell

Yes, the numbers exclude Toulouse now, yes.

Operator

Our next question comes from Doug Freedman of RBC Capital Markets.

Doug Freedman - RBC Capital Markets, LLC, Research Division

When I look at the guidance that you've offered by business group, it looks like 3 of the segments are staged to grow in Q3 and 3 are flat. And when I work through the math, it actually means that those 3 groups have to be growing pretty significant, high-single-digit type of numbers with the other groups being flat. Can you just offer a little color? Am I getting a little too aggressive on those other groups? Or is flat sort of up 1% to 2%? If you could just give me just a little bit of color around what we should see.

Alan Campbell

Yes, I think I'll give you some color on that, Doug. Directionally, you're correct. First of all, on Microcontrollers, we do expect the growth there to be higher than -- on a percentage sequential basis to be higher than the other businesses. Part of that is seasonality, part of that is the focus on consumer markets into Q3. And the rest of the business, as we've said, the Automotive, Analog & Sensors is relatively flat, which is actually positive related to the historical seasonality where we actually see the auto business down. And we expect Digital Networking to be slightly or modestly up.

Doug Freedman - RBC Capital Markets, LLC, Research Division

All right. Can you give us a little -- if I dig into the MCU business a little bit, I know you've got some new product families there that are based on the ARM core. Has that reached a material percentage of the mix? And can you just help us understand what might be the drivers of some of your strong strength -- your strong numbers that you're putting up in MCUs?

Mitch Haws

Doug, this is Mitch. There's 2 things to keep in mind. One, is we're seeing the ramp in the 32-bit Kinetis family of products, particularly into distribution. So if you look back at Q2 and into Q3, it's becoming a pretty meaningful part of the revenue. The other thing that is included -- or the other item included in the Microcontroller product group is the applications processor family. So there is some legacy business goes into a bunch of different embedded devices, and we're seeing very good growth into the automotive market with that same ABS processor family. In addition, you're seeing good growth in different consumer applications with MCUs. So part of what's going on in Q3 is seasonality. A big part of is the growth of the 32-bit line and a lot of success with the ABS processor line into automotive. Those are -- if you're ranking the big levers, those will be the ones.

Operator

Our next question comes from Gus Richard of Piper Jaffray.

Auguste P. Richard - Piper Jaffray Companies, Research Division

I think most of them have been answered. I just wanted to ask about how to think about taxes going forward. And if you can just give us a little bit of color on how to model that, that will be great.

Alan Campbell

Yes, the way that we're looking at taxes is on a cash basis. And our annual cash tax base is in the range of $10 million, $15 million, $17 million per year. So very low cash tax is basically driven by some of the jurisdictions. But for modeling purposes, probably $4 million -- $3 million, $4 million or $5 million type per quarter is good for modeling.

Operator

Our next question comes from Jeff Harlib of Barclays.

Jeffrey A. Harlib - Barclays Capital, Research Division

Gregg, can you talk a little bit about European automotive, what you're seeing from your customers there given continued weakness in that market?

Gregg A. Lowe

Well, first off, the European market has, for cars -- or for automotive, has essentially stabilized, which is better than what's been happening in the past, which has been kind of declining. So the -- it's kind of looking like it stabilized at this point. And then the second point that I'd make is a lot of our customers that are based in Europe are -- have designs that go pretty much worldwide. So -- although we have some very strong partners and customers in Europe, they aren't exclusive -- exclusively beholden, if you will, to just the European automotive market.

Jeffrey A. Harlib - Barclays Capital, Research Division

Okay, that's helpful. And Alan, just a few things on, first, CapEx increasing. Can you just talk about -- is that more front end, back end? And do you see yourself moving to the high end of your 3% to 5% of sales? And then also, cash restructuring, what that was in the quarter? And if there any other unusual cash items in the quarter?

Alan Campbell

Yes. So the CapEx, we do expect to increase, but I do not believe about the 5%, but it will be somewhere between the 4% and 5%, Jeff. There's a lot of puts and takes with the cash, pretty candidly. I think we did see a significant benefit in working capital as we discussed. We did have some severance charges associated with the closure of our -- of Toulouse facility. And total of that was nearly -- and total severance, including Toulouse, was roughly about $45 million in the second quarter. There was some deferred revenues. So a lot of puts and takes that we'd see overall. Obviously, we're very happy with our performance in cash management and that's reflected in the fact that we're able to take another $100 million and take out some additional maturities.

Operator

Our next question comes from Tony Venturino of Federated Investors.

Tony Venturino

Alan, just quickly, when you guys started on this restructuring process way back when, you talked about 75 to 100 basis points of gross margin improvement per quarter going forward, and you're calling for that next quarter. I mean, the past few quarters that when volumes kind of sell off, you backed off of that a little bit. Should we maybe think that that's now the trend again going forward?

Alan Campbell

Tony, a couple of comments. First of all, I think the normalized basis that we set for gross margin historically was 58 to 75 basis points. That was, obviously, the initial model. We then increased that to 75 to 100. And no, we're not backing off the targets. It's very clear to the 18,000 employees in the company, the 2 goals of revenue growth and margin expansion. So absolutely not backing off. In fact, as described there in the call, we do have great detailed building blocks to continue to execute on gross margin.

Tony Venturino

Well, I thought that maybe this was, not that you're backing off, but maybe it was volume-dependent. And so a few quarters ago, it wasn't really materializing in the way you had anticipated because volume wasn't there. So is that maybe, given the outlook going forward, is that remedied, I guess?

Alan Campbell

It's not just volume-dependent. Obviously, we have had some tailwinds with the utilization of our factories. But that's one element of the 4 elements. I think the operational efficiency is our major focus within the company. And we did guide utilization relatively flat from Q2 to Q3. And despite that, we do expect margins to improve.

Gregg A. Lowe

Okay. Well, thank you very much, everybody, for joining in -- joining our call and for your interest in Freescale. The company is now focused on 2 objectives: top line revenue growth and margin expansion. And in order to do that, we need to be working with our customers and delivering to them great products, great operational efficiency, great quality and great service. As many of you may know, I spend a lot of my personal time out at customers. I've met many customers worldwide. And I would say they are excited about our focus and they're excited about the future potential of working together with us. With that, thank you again for your interest in Freescale, and we look forward to talking with you and sharing our results as we finish up Q3. Thank you.

Operator

This concludes today's conference. Thank you for your participation. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Freescale Semiconductor Ltd (FSL) Management Discusses Q2 2013 Results - Earnings Call Transcript

Check out Seeking Alpha’s new Earnings Center »

This Transcript
All Transcripts