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Freescale Semiconductor Ltd (NYSE:FSL)

Q4 2013 Earnings Call

January 28, 2013, 5:00 PM ET

Executives

Mitch Haws - Vice President, Investor Relations

Gregg Lowe - President, Chief Executive Officer, Director

Alan Campbell - Senior Vice President and Chief Financial Officer

Analysts

John Pitzer - Credit Suisse

Jim Covello - Goldman Sachs

Craig Hettenbach - Morgan Stanley

Ross Seymore - Deutsche Bank

Harlan Sur - JPMorgan

Stacy Rasgon - Sanford Bernstein

William Stein - SunTrust Robinson Humphrey

Doug Freedman - RBC Capital Markets

Rajvinda Gill - Needham

Operator

Welcome to Freescale's fourth and full-year 2013 results conference call. All participants are in a listen-only mode until the question-and-answer portion of today's conference. 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. Sir, you may begin.

Mitch Haws

Thank you, Sharon and welcome everybody to our fourth quarter and 2013 year-end 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 today's prepared remarks, I would like to remind everyone that today's discussion contains forward-looking statements that are based on our current outlook. As such, 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 specific risk factors that could cause our actual results to differ materially. The company does not assume any obligation to update any of today's forward-looking statements to reflect subsequent events or circumstances.

Finally, we will reference non-GAAP financial measures. We have posted the appropriate GAAP financial reconciliations at our website at freescale.com.

With that, I will turn the call over to Gregg.

Gregg Lowe

Thanks, Mitch, and good afternoon, everybody. I will spend a couple of minutes highlighting our Q4 and calendar year 2013 results, after which Alan will provide some additional insight into the financials and provide our Q1 2014 guidance. Following Alan's comments, we will take any questions you might have.

Now looking at the results, both Q4 and calendar 2013 show that we are starting to make good progress on our goals of gaining share and increasing margins. We are still in the early stages of what we believe we can ultimately accomplish but we are building some good momentum.

Looking at Q4, revenues were $1.08 billion, modestly ahead of the upper end of our guidance and essentially flat with Q3. Core product revenues grew $11 million sequentially which is ahead of normal seasonality. Gross margins were 43.9%, up 30 basis points from Q3 and adjusted earnings per share of Q4 were $0.19.

For the year, revenues were $4.19 billion, 6% ahead of last year and revenue for our five product groups was up 9% compared to last year. Gross margins for 2013 were 110 basis points higher than they were in 2012. Overall, we had some good success in 2013. We gained market share, our gross margins increased in each quarter throughout the year, each core product group grew faster than the market led by our microcontroller business which was up 17% in 2013.

Operating expenses declined as a percent of sale, even during the year, in which we added back variable incentive compensation. Adjusted net income grew $135 million from last year and adjusted EPS improved by $0.53. So overall, some pretty good progress but there is plenty left for us to accomplish. Our team is focused on continued improvements in both market share and margin.

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

Alan Campbell

Good afternoon and thank you again for joining today's call. Looking at Q4 and 2013 now in more detail, revenues were $1.08 billion, in line with the third quarter and 13% ahead of Q4 last year. On a year-over-year basis, revenues grew 6%. As Gregg referenced, revenues for all of our five product groups increased 9% over the same period last year.

Looking at the product groups in more detail our microcontroller sales declined 4% sequentially in line with normal seasonality. Compared to Q4 of last year, our microcontroller sales grew 12% and for the full-year sales grew 17%. Through 2013 we saw strong growth in our 32-bit microcontrollers sold to both OEMs and distributors worldwide. In addition, sales of our application processors in to the automotive and distribution channels also grew year-over-year. Looking into 2014, we are optimistic about the continued growth opportunities in this business.

Digital networking revenues grew 3% from the prior quarter and grew 26% compared to Q4 of last year. Revenues did benefit from growth in wireless infrastructure spending, particularly in China as well as growth in enterprise. On a year-over-year basis, our digital networking revenues grew 7%. This year-over-year growth was broad-based with growth in service provider, enterprise as well as distribution for our general embedded products.

Our automotive microcontroller sales were essentially flat with the third quarter and were up 13% to Q4 of last year. For the full-year, our revenues grew 8%. The businesses benefited from solid production and sales levels in North America and China and modestly improving conditions in Europe.

Analog and sensor sales were 5% ahead of our third quarter and 9% above Q4 of last year. Again for the year, analog and sensor sales grew 2%. The sequential year-over-year growth was due primarily to growth in our auto production during 2013.

RF sales grew 8% from Q3 and they were in line with the fourth quarter of last year. RF sales grew 16% year-over-year. The increase in RF sales was due to the growth in our wireless infrastructure investments, particularly in China.

Other products which consist primarily of IP revenue and the remaining cellular handset revenue declined 18% from Q3. Both IP and cellular revenues declined sequentially. On a year-over-year basis, net sales declined 22% due to the planned wind down of our cellular handset business.

Finally sales through distribution declined 2% sequentially, overall 19% compared to the same point last year. On a year-over-year basis, sales through distribution grew 14%. In early January of this year, we consolidated a number of global distributors from three to two. Over time, we believe this will result in more resources dedicated to our products and better field support as we continue to grow our business through the channel.

We did reserve a small amount of Q4 revenues related to the potential impact of this transition and we do continue to use [various] [ph] and specialized distributors in different regions of the world. Our distribution inventory grew by $19 million compared to the prior quarter. Weeks of inventory, however, were flat at 9.1 and actually down from 9.7 in the fourth quarter of last year.

Our book-to-bill ratio in the fourth quarter was 1.04. This compares favorably to 1.03 in the prior quarter.

Now looking at our gross margins and operating expenses. Our gross margins were 43.9. As Gregg mentioned, this compares to 43.6 in the third quarter. The 30 basis point sequential improvement was driven by ongoing operating efficiencies and procurement savings that more than offset the impact of lower factory utilization and lower IP revenues. Compared to fourth quarter of last year, gross margins were up 470 basis points, due primarily to higher utilization from higher sales and continued operational and procurement benefits. For the full year our gross margins increased 110 basis points representing a 60% fall through for the year.

Our front end factory utilization was approximately 86% in the fourth quarter. This compares to 89% in the third quarter and 71% in the same period last year.

I will now turn to our operating expenses. Operating expenses were slightly up from Q3 and represented 28.9% of sales. On a full-year basis, our operating expenses as a percent of sales declined from the same period last year. The decline in operating expenses as a percent of sales was noteworthy given the fact that we reinstated variable compensation during calendar year 2013. Looking at operating expenses over the next few quarter we do expect to modestly increase our spending due to a combination of variable compensation and investments to continue to expand our product pipeline.

As Gregg mentioned earlier, we did see some progress in market share during last year and we want to continue to invest in a way that helps us maintain that momentum. It is important to note that the increase in operating expenses as a percent of sales was modest, at roughly 30% and is expected to decline as sales are expected to improve in the coming quarters.

Adjusted operating earnings were $174 million or 16% of sales. This was in line with the third quarter and favorably compares to the $91 million or 10% of sales in the prior year: For calendar '13, our adjusted operating earnings were $616 million or 15% of sales. And again, this compares favorably to prior year of $504 million or 13% of sales.

Included in the 2013 results is $217 million of cost associated with debt refinancing transactions completed during this year. In total we refinanced approximately $4.8 billion in debt. The refinancing transactions will reduce our annual interest expense by approximately $70 million based on current interest rates. Importantly 90% of our debt now matures in 2020 or later.

Adjusted net earnings in the fourth quarter was $50 million, exclusive of debt refinancing reorganization charges and share-based compensations. This compares to adjusted earnings of $51 million in Q3 and a loss of $37 in the same period last year. Adjusted net earnings per share, exclusive of those adjustments mentioned earlier, was $0.19 compared to adjusted net earnings per share of $0.20 in Q3 and adjusted net loss of $0.15 in Q3 of last year. For the full-year, adjusted net earnings grew $135 million and adjusted net earnings per share were $0.45 compared to a loss of $0.08 in 2012.

EBITDA in the fourth quarter was $236 million, up 22% of sales. This was flat with third quarter and above the $152 million reported in the fourth quarter of last year. For the full-year, our EBITDA was $862 million. Again this compares favorably to the $744 million of last year. Adjusted EBITDA was $893 million on a trailing 12 month basis.

I now turn to cash and cash equivalents. We ended the year at $747 million. This compares to $700 million in the third quarter. Operating cash flow in the fourth quarter was $180 million. We made progress in the fourth quarter with working capital which represented a $45 million source of cash in the quarter.

Our inventory dollars grew slightly from Q3 and inventory days were 110 compared to 108 days in the third quarter. Excluding inventory related to the Toulouse transition, our inventory days were at 105.

Capital expenditures for the quarter were $44 million or 4% of sales. For the calendar year, our capital expenditures were $151 million or 3.6% of sales. Given our consistent execution in managing cash, we continue to have solid liquidity. Our cash, cash equivalents coupled with our undrawn revolver of approximately $400 million, affords us the opportunity to continue to invest in the business, on the capital expenditures and continue to delever.

I will now take a few minutes to discuss the outlook for the fourth quarter. Based on the current outlook we expect Q1 revenues to be in the range of $1.07 billion to $1.11 billion. This revenue would imply a high level of automotive microcontrollers and our RF revenues grow nicely into the first quarter. Our microcontrollers and analog sensor revenues grow modestly from Q4. Our digital networking and IP revenues decline sequentially. Finally we do expect gross margins to be up approximately 50 to 75 basis points sequentially.

At this point, let me now turn the call back to Gregg.

Gregg Lowe

Thanks a lot, Alan. Well we have made some progress in gaining share and improving our profitability. We are well-positioned in markets that are expected to outgrow the core semiconductor market and the team is aligned and focused and well aware that much remains to be accomplished. We appreciate your support and look forward to sharing future successes.

At this point, we will open the call to any questions you might have.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). Our first question comes from John Pitzer of Credit Suisse. Go ahead, sir. Your line is open.

John Pitzer - Credit Suisse

Yes. Good afternoon, guys, and congratulations on the strong results. Gregg, I guess my first question is, trying to get a little bit better understanding of your exposure to the Chinese wireless CapEx cycle. I appreciate that it spans across digital networking and RF but how do we think about that as a percent of revenue in those two buckets today?

That's always been a lumpy business. So I am kind of curious about, one, sustainability, and two, if you look at the current run rate from the December quarter, how much potential upside on a quarterly basis could you envision as we go throughout 2014? And then I have a follow-up.

Gregg Lowe

Okay, I will open it up and then turn it over to Mitch, maybe, for a little bit more color. The RF business obviously has a pretty significant exposure to the base station market and certainly has great exposure to the China expansion. So a significant percentage of that business is based on the base station business and the exposure we have there. We have got a large market share in RF and that's benefiting very, very nicely from that expansion.

The digital networking business has a lot more components to it. So the base station exposure is significantly smaller in digital networking. It is seeing some of the benefits due to the LTE rollout that you may have seen in the press. So we are seeing some benefit to that but we have got exposure to a lot of other markets in digital networking.

Maybe I will turn it over to Mitch for additional color.

Mitch Haws

Yes, John. If you look at digital networking's revenue, probably a third of it would be base station related, the other two thirds is outside of that. So if you look at their business last year, it was clearly a benefit from LTE. Their multicore revenue however grew about 140% this year and reached about 30% of total digital networking revenue. That 30% probably goes closer to something like 40% next year.

John Pitzer - Credit Suisse

That's helpful, guys. Then, Gregg, as my follow-on, looking at the success you guys had in the microcontroller market this year, you guys were up almost 17% year-over-year. I think if I look at the SIA data, the category was effectively flat year-on-year in 2013. I am wondering if you could help me understand given that microcontrollers is sort of a catchall phrase, what verticals or applications do you think, what drove the growth in 2013 from a vertical application and what do you think continues the growth in '14?

Gregg Lowe

Well, our business in the microcontroller business is pretty fragmented. It looks a lot like analog business to be frank. It has a significant number of customers that are relatively small. So there isn't single points of exposure that dramatically change things, one quarter to the other. I think the team has done a fabulous job in generating a set of products, releasing hundreds of new products based on the ARM core that has captured the interest of customers. We have got products that have very low power dissipation, that are small that can be used in a broad set of applications. More and more things are being connected to the Internet. The catchphrase is the Internet of Things and that is driving good growth for our business. So I think execution was very nice in 2013 and again we are feeling pretty bullish about the business in 2014 as well.

John Pitzer - Credit Suisse

Gregg, would you expect that to lead the growth within the product revenue divisions again this year?

Gregg Lowe

I don't know if I want to get into that level of detail. What I would say is, with the amount of design win success we have, with the excitement that we have had from the customer base, I think the reaffirming that microcontrollers are a key core part of our portfolio and that was part of the strategy that we laid out a year and half ago, I think has given customers a lot more confidence in designing us in and we definitely are planning for growth in 2014 in that business.

John Pitzer - Credit Suisse

Very helpful. Thanks, guys. Congratulations, again.

Gregg Lowe

Thank you.

Operator

Our next question comes from Jim Covello of Goldman Sachs. Go ahead, sir. Your line is open.

Jim Covello - Goldman Sachs

Great, guys. Thanks so much for taking my question. I appreciate it. First, Alan, let me offer my congratulations on a terrific career there at Freescale, given the announcement of the retirement in between calls. So congratulations on all your great success.

Alan Campbell

Thanks, Jim.

Jim Covello - Goldman Sachs

I guess, when you think about the first quarter guidance, it seems a little bit stronger than the peer group. How much of that do you think is related to the markets that you are exposed to versus you guys maybe taking a little bit of share against some peers in terms of driving above industry average growth in the first quarter?

Gregg Lowe

Well, I would take a crack at that. It's hard to say, quarter-on-quarter, too much from a market share standpoint. I have always been cautious on that. I think 2013, we gained share. We were up roughly 6%, I think, in the market that we compare ourselves to and it was essentially flat or up maybe a point or something like that. So we feel pretty good about that. Obviously in the guidance we talk about the RF business and the automotive microcontroller being up nicely. We talk about the microcontroller and analog sensors being up as well. I think automotive is certainly a decent market right now and I think we get some tailwinds from that, but overall I feel like we are starting off the year pretty well and hopefully we will keep the momentum.

Jim Covello - Goldman Sachs

That's great. And for my follow-up, maybe I will come back to Alan on the balance sheet. Incremental refinancings here, is the priority to further extend the maturities or to lower the interest rate?

Alan Campbell

Ultimately it will be to continue to lower the interest rate, Jim. I think 2013 saw a lot of work done by the team here. We refinanced just under $5 billion of debt which will likely give us a $70 million interest saving, as we look into 2014. We will continue to be proactive and look at what opportunities exist within the capital structure, as we move forward. So I think a lot of focus will be on the reduction of interest as opposed necessarily to extension since 90% of the maturities are now 2020 and beyond.

Jim Covello - Goldman Sachs

Great. Thanks so much and congratulations again.

Alan Campbell

Thank you.

Operator

Our next question comes from Craig Hettenbach of Morgan Stanley. Go ahead, sir. Your line is open.

Craig Hettenbach - Morgan Stanley

Yes. Thank you. As you look at gross margins for Q1 and going through the year, can you talk about how much company specific drivers you think you have in place and then also the implications on utilization and topline?

Alan Campbell

Thanks for the question, Craig. First of all, there are basically four elements of building blocks that we have communicated on our gross margin. One is utilization, and we ended the fourth quarter at 86% and that was actually slightly down from the third quarter and we communicated we also improve margins. So we expect some benefit as a result of utilization and we have communicated also that 25% to 30% of every the point of utilization should see an improvement in gross margin.

The operational efficiency is quite a large one for us and we did see some traction here in Q4 and the operational efficiency really has bucketized into three elements. One is our existing legacy product portfolio and two, a lot of the new products and we do believe there is a lot of opportunity here. There is blocking and tackling. There is testing. There is yield. And we have seen the benefit. The final one is really procurement but 35% of our business today is outsourced and we can partner with the many partners that we have got and we have to continue to work together to cost reduction and get procurement reductions. So these are the main building blocks and as we look out into 2014, our expectation is for continued sequential improvement. Again there will be some quarters we exceed and maybe some quarters that actually slowed down but overall we should have a regular drumbeat of continued sequential improvement with our gross margin.

Craig Hettenbach - Morgan Stanley

Got it. Thanks for that. Then just as my follow-up, within digital networking, it sounds like the comp process there, particularly in multicore is still seeing very strong momentum there. Can you provide any color in terms of visibility, in terms of what you are thinking about, from market share perspective, for 2014 in that business?

Gregg Lowe

Yes, the multicore product line is growing very, very, rapidly. We had greater 100% last year. We are seeing very nice growth in to the first quarter. Maybe I will let Mitch give you a little bit more color on market share for the multicore.

Mitch Haws

Yes, if you look at 2013 in total, not everybody has reported yet, but it's clear we had a good year in terms market share in 2013. A part of what drove that was multicore the Gregg referenced that's in a variety different enterprise applications all of which grew strong in 2013. LTE grew as well during the course of 2013. There are some legacy architectures there decline as LTE expands and CDMA and other things will decline. So you have to take that into account, but if you look at 2014, the key drivers that helped them in '13 should repeat again. It's a very good product portfolio. Very broad, very power efficient. The adoption of the multicore offering that we launched a couple of years again was very well-received this year and good prospects for market share again next year, or this year, I should say.

Gregg Lowe

And just maybe one last reference point. We talk about significant growth in this business, greater than 100% last year. Just kind of keep in mind, that multicore is now at roughly 30% of the digital networking business. So it's a sizable business that's growing very rapidly.

Craig Hettenbach - Morgan Stanley

Got it. Thanks for that.

Gregg Lowe

Thank you, Craig.

Operator

Our next question comes from Ross Seymore of Deutsche Bank. Go ahead, sir. Your line is open.

Ross Seymore - Deutsche Bank

Hi, guys. Before the questions, I also wanted to echo the congratulations to Alan and wish him good luck. I guess, my first question on the revenue side of the equation, in 2013 your automotive MCU in your sensor had a pretty big delta between the two. Can you just talk a little bit about the growth rate delta there and what's going on that the analog and sensor side is growing relatively slower?

Alan Campbell

Yes. Let me take that one and Gregg or Mitch can add to it. So we did see, to recap, our automotive microcontroller revenues growing 8%, while our analog and sensor business growing 2%. And we actually did have similar type growth but the reason that the growth percentage was a little bit lower in our analog and sensor was we built end-of-life inventory in 2012 associated with the closure of our factories. So it was a little bit inflated in some respects in 2012 which makes the percentage actually a little bit smaller but it was, again, good traction with auto side of the end of life build.

Ross Seymore - Deutsche Bank

So you would expect those to grow relatively similarly going forward from this point?

Alan Campbell

Yes. I would expect the growth. They won't necessarily be similar because of multitude of different stage of applications but it should certainly be closer.

Gregg Lowe

I think both of them have are great opportunities and for both topline and margin expansion.

Ross Seymore - Deutsche Bank

Great, and I guess as my follow-up, Alan, you alluded a little bit to OpEx as a percentage of sales, I think, for the first quarter. Can you give us a little more color on what's going on there, maybe on a dollar basis, how we should think about that progressing through the year? And then what interest expense level should we be modeling for the first quarter? Thanks.

Alan Campbell

Yes. So let me make a couple of comments on maybe operating expenses. I would say that we continue to tightly control and manage. If you look at 2013 over 2012, as a percentage of sales, they were down just from 29.9% to 29.1%. The dollars however increased from 2012 to 2013 and it's fair to say that most if not all of our increase was variable compensation. So it's the base expenses that was somewhat in check.

As we look out into the first quarter, we would expect our percentage of sales to be relatively flat, maybe up a little which would mean dollar increase of $6 million, $7 million. I think it's probably about 40% of it is going to be again associated with variable compensation. It's also fair to say that we want to put a little, a modest amount of money into some of the growth that we have seen and are guiding to. So we are investing a very modest amount there.

On interest expense, we ended the fourth quarter of $119 million. I think the expectation is that that will probably reduce by about $10 million into the first quarter.

Ross Seymore - Deutsche Bank

Great. Thank you.

Operator

Our next question comes from Harlan Sur of JPMorgan. Go ahead, sir. Your line is open.

Harlan Sur - JPMorgan

Great, good afternoon and nice job on the quarterly execution. Going back to your MCU business, I know somebody had addressed this question earlier but it looks like that segment grew about two or three times the rate of the overall market in 2013. So as you look at your design win pipeline, uptake of some of your newer 32-bit products like Kinetis, how should we think about growth in that business this year relative to the market? What are the products and the end markets that are going to be driving the strength this year?

Gregg Lowe

Yes, we have literally hundreds of products that have been introduced recently in that portfolio now. It is quite sizable. We are seeing very nice growth across a number of different markets. As I mentioned earlier, there's hundreds, well thousands of customers in this kind of business. So I think going into 2014, when I look at the opportunity, we saw really nice design win results in 2013 and some of the growth that see in 2014 will be based on that as well. So I guess what I would say is, we are pretty bullish about the microcontroller business. It's kind of a foundation business for the company.

When customers think of us, they think of us as a microcontroller company. I think the fact that a year and a half ago we restated that that is going to be core to what we are doing and its going to be a core driver for us, is a key thing. Our distribution partners are really excited about the expansion of the portfolio because it gives them an ability to take new stuff into customers. So I would say overall we are pretty positive about that. Again, we he can't point to any one particular socket. I would just say the connectivity to the Internet and the so-called Internet of things is certainly playing a big role in it.

Harlan Sur - JPMorgan

Great, and then the wireless infrastructure market, from a technology perspective, is still DMOS-based, but there's a broad array of technology applications for gallium nitride focused products on next-generation COM infrastructure, aerospace and defense technologies. Any updates on the roadmap for your GaN-based RF products? When do you expect GaN to become a more material part of the overall RF business?

Gregg Lowe

Well I don't think we want to get into the technology roadmap at this point. Obviously we are well aware of all of the technology drivers out there and we are playing a role in each of those. I think at this point, maybe I will just leave it at that, but that team has done a great job of developing products that differentiate themselves, that have performance and features that customers are excited about and are obviously continuing look at how do they continue doing that in the future. That includes design techniques, process technologies, even new IP building blocks that leverage some of the things that we do across the company. So they are working really hard on that.

Harlan Sur - JPMorgan

Great, thank you.

Gregg Lowe

Thank you.

Operator

Our next question comes from Stacy Rasgon of Sanford Bernstein. Go ahead. Your line is open.

Stacy Rasgon - Sanford Bernstein

Hi, guys. Thanks for taking my questions. First, I just wanted to drive a little bit into the OpEx model. So you are running a little bit ahead on R&D right now. It sounds like it goes a little bit more ahead next quarter. Is your 17% R&D as a percentage of revenue, is that still the right model to think about in the long-term? And does this, I guess the additional cost now, just drive revenue growth in the future to grow into that? Or do you think it's possible that you might want to take that model up slightly in order to invest as the revenue growth is coming back?

Gregg Lowe

I don't think we will be taking it up in any kind of meaningful way. I think that we see a lot of great traction right now. It's a little bit more in this particular quarter and Alan mentioned, that's a modest amount but I think that kind of percentages is really fine. If fact, it is probably at the top end of, long-term, where we want to be.

Stacy Rasgon - Sanford Bernstein

Got it. I also wanted to dig just very quickly into the short-term. You have a book-to-bill that's decently above one, flat guidance. We had something similar last quarter and you wound up beating by a fair amount on the topline. How do I think about a book-to-bill at 1.04 with flat guidance? Is this indicative of some kind of leadtime extension or what? How should I be thinking about this?

Gregg Lowe

Well, maybe I will start off and then Alan can give a little bit of color. We are up slightly at the midpoint. I believe its 1% at the midpoint but that does include some IP revenue declining in the quarter. So I think first quarter revenues are actually well above seasonality.

Alan Campbell

Yes, and I would say a couple of things, Stacy. One is that our core revenues are flat to up 1% in terms of the guidance we have given. If you look at our core product revenue however, and take that IP decline as well as all our overall decline in the wireless, it will be up over 3% and that likely compares to normal seasonality of down 3%. So I think it's well supported of the 1.04 book-to-bill when we look at the components.

Stacy Rasgon - Sanford Bernstein

So what's driving that? Is that market growth in Q1? Is it share gain in Q1? Is it inventory builds in Q1? What's driving the above seasonal growth?

Gregg Lowe

It's hard to just point out and say it’s definitely market share or definitely this or that. What I would say is we are seeing very nice growth automotive MCU business and our RF business. Those businesses are historically really strong market share components for the company. So I think it's a pretty good execution. Our microcontroller business and the analog sensors will also contribute positively in quarters where there's normal seasonality decline. So overall we are pretty satisfied with how we are starting the year and the one thing you will continue to see from us is we still have long ways to go. So nobody is dancing in the end zone. We have got with a lot of hard work. It's nice to start off the year ahead of seasonality but we have got a lot more work to do.

Stacy Rasgon - Sanford Bernstein

Got it. Thank you, guys. I appreciate it.

Gregg Lowe

Thank you.

Operator

Our next question comes from William Stein of SunTrust Robinson Humphrey. Go ahead. Your line is open.

William Stein - SunTrust Robinson Humphrey

Great. Thanks for taking my question. I am hoping you can talk, Gregg, a little bit about the strategic initiatives that you have outlined in the past. In particular, while you commented about consolidating your global disti partners, maybe talk a little bit about your longer-term plans for growth in disti. Also your exposure to China. I think you talked about opening 10 offices by the end of 2013. I am assuming you hit that. And also, I think there was at least one other and it related to the percentage of R&D that was allocated to growth opportunities. And maybe any other strategic things that you would like to maybe elaborate on the progress?

Gregg Lowe

Great. Thanks. Let me just hit those one at a time and let me just start off with the redeployment of R&D. Our objective was to have 90% of our R&D spend in those areas of growth that we had talked about when we kicked off the strategic realignment. The objective was to get to 90% by 2015. At the end of 2013, Q4 2013, we are 89%. So we are pretty much there two years ahead of schedule and I think that's now turning into -- new products are coming out, and it's improving the portfolio and that's building some design win momentum which turns in to revenue momentum and so forth.

On the growth in China, we did indeed open up all those offices last year. We added a significant amount of sales people into those offices and we also significantly increased the number of customers we are directly calling on. If you look over the year, we well exceeded our goal of 400 new customers that we are calling on. We are well over 600 now just in one year's time. So that is an outstanding result.

I don't want to go into the details, but we are also measuring our design win and an our revenue traction in those new offices and I would just tell you, the early indicators are very positive and customers love the fact that we have local support, a local presence. We have always had strong technical capability in China. We have got multi-hundreds of design engineers and app engineers and so forth in China and now we are leveraging those folks with local field sales people to help drive growth.

I think on the distribution consolidation. We are consolidating from three global distributors to two global distributors. We have maintained that we have got local distributors and some specialized distributors in different regions of the world but that consolidation is actually going to give us, we believe, incrementally more resources. This is going to make us more important to the remaining two global distributors. So it obviously increases our business with those guys and we are really excited about the opportunity to have a more focused distribution program that we believe is going to help drive topline revenue growth and market share increases.

So I think this is going to be a really strong positive for us. I am sure there will be some working through the transition but I think we announced this in early part of January. We have very focused and dedicated people, both inside of Freescale and in the two global distributors that have selected working on, making this a seamless transition for our customers and certainly something that we believe will drive growth.

William Stein - SunTrust Robinson Humphrey

I appreciate that. If I can have one follow-up. You have made good progress on gross margins despite IP revenue falling, which speaks of course to the procurement and other initiatives you have underway. Can you talk about, or maybe remind us of the target gross margin, kind of medium-term target, what kind of revenue you think it takes to get there, over what kind of timeframe you would hope to hit it?

Alan Campbell

Yes, William, let me take that. I think we would expect in the $11.50 to $11.75 revenues per quarter. So we should be in the higher 40% range. Our expectation is to help this continued drumbeat of sequential improvement in our gross margin driven primarily by the operational and procurement savings, but that should give you some kind of directional thought process in our higher 40s when we get that revenue.

Gregg Lowe

I think when you look longer-term and you look at the kind of markets that we are in, the kind of technologies that we have, the positions we have in those markets, this is a business that is capable of earning greater than 50% gross margin. We don't put any timeline on that but what I would say is the fundamental of this business should be ale to get us there. The approach that we have been taking is very much aligned to what Alan talked about. These is four components to at. We are working all of those and their is a lot of fundamental, Alan described his blocking and tackling that we are doing inside of the company that is incremental improvement every quarter. So the company has two goals companywide and one is topline revenue growth and the second is margin expansion. Our variable compensation is related to those two things. So as we do well on that, the folks get the non incentives. Lining up those incentives to those two priorities, I think it's a real big positive for us.

William Stein - SunTrust Robinson Humphrey

Great. That's helpful. Thank you.

Operator

Our next question comes from Ambrish Srivastava of BMO. Go ahead, sir. Your line is open. Ambrish Srivastava from BMO, your line is open.

Gregg Lowe

Maybe we can go to the next question, operator, if there is one.

Operator

Thank you. Our next question comes from Doug Freedman of RBC Capital Markets. Go ahead, sir. Your line is open.

Doug Freedman - RBC Capital Markets

Great. Thanks for taking my question, and again I would like to echo congratulations, Alan, on your retirement. For my first question though, can you give us a little sense of the gross margin impact that we might see as a result of the product line mix? You have talked a lot about structural changes in the business but is there much of a swing factor from changes in the product mix?

Alan Campbell

The reality of it is yes, but our expectation, Doug, is growth and margin as we talked about. Growth is across all five product mix and margin expansion is also across all five product groups. So when I say look at this, some of the product groups have higher expectations of growth in gross margin. So I think it's fair that from our product portfolio within the product groups, that really is across the company and expectation is that everyone of those five product groups has a assist with the growth and margin expansion.

Doug Freedman - RBC Capital Markets

Okay. You talked a little bit, Gregg, already about the change in disti. Alan, could you give us a little bit more clarity on the inventory charge you mentioned in your preamble. How long that charge will be carried and what is the impact that we might see from this channel consolidation?

Alan Campbell

Our inventory is currently at distribution of about just over nine weeks which is relatively flat and actually down from the same period last year. We did take, I would say, a very modest charge of, I don't want to communicate what it was, but we don't anticipate all our charges coming through but we can never tell. So I don't believe that is a risk with inventory that we moved out remaining at distributors. Embedded in our guidance that we have given, Doug, a revenue guidance assumption that we move from the three to two distributors.

Doug Freedman - RBC Capital Markets

Okay and if I could, for my last one, there were some restructuring charges this quarter. Are there any planned restructuring charges that we should be taking into account for our GAAP accounting going forward in the balance of this year?

Alan Campbell

I would say minimal. The restructuring charges in the fourth quarter of $14 million, that really was some of the strategic initiatives we put in place and was predominantly associated with moving from three states in Austin to two states and that's now being complete. So we may see smaller amounts but nothing of significance under the restructuring length.

Doug Freedman - RBC Capital Markets

Great. Thanks so much and congratulations on the strong results.

Gregg Lowe

Thanks, Doug.

Alan Campbell

Thanks, Doug.

Operator

Our next question comes from Rajvinda Gill. Go ahead, sir. Your line is open.

Rajvinda Gill - Needham

Thank you and congrats on good results as well and good execution. Alan, just a question on the capital structure. If you are doing $893 million of trailing EBITDA and your current debt outstanding is around $6.4 billion, if you assume that you are on track, maybe to do $900 million of EBITDA or something greater next year, theoretically you could pay off the entire debt load in six years or 6.5 years. So I just wanted to get a sense of how you are looking at the capital structure? How is the management team is looking at the capital structure over the next couple of years? And if last year was a lot of refinancing, the interest rates, maybe they might rise, we don't know exactly what the situation will be, will you use your free cash flow to pay down debt? If you could talk a little bit about that over a long-term basis.

Alan Campbell

I think it is important again to just, I may sound redundant in this call but really the focus of the company was on revenue growth and margin expansion. We have talked about revenue growth giving us a 60% follow through to cash and now obviously the facility continued deleverage of balance sheet. So that's where we are. The capital structure that we did again in 2013 was significant and it continues to evolve and practically manage all our opportunities.

In terms of the interest rates, our interest will decline 2013 to 2014 by approximately $70 million with continued enhancement of revenue that does give us an opportunity to pay down some of it in 2016. Embedded in there are some sub notes, at 10.125 which is quite an attractive to probably just interest and improve EPS. So I think the message is that really is clear consistent revenue growth, margin expansion, cash fall-through to delever and we will continue to be focused on that.

Rajvinda Gill - Needham

Okay. Very good. Then just, Gregg, we talked a little bit about the wireless infrastructure, particularly in China, boosting the RF business. Maybe if you could elaborate a little bit further in terms of what you are seeing on the China LTE builds on the ground? What are your expectations for China mobile or maybe for the broader China LTE CapEx cycle this year and over the next year?

Mitch Haws

Raj, this is Mitch. If you look at the third quarter and fourth quarter, both are up with so much concentration in the revenue on base stations. It was couple of quarters at 8% growth, it will grow again in the first quarter. So we have good exposure to all the vendors in that particular part of market. Wireless infrastructure can ebb and flow, as you know, but we are seeing good success. It's less apparent in digital networking based on the composition of revenue but it's clear that we are going to benefit. It's possible that you could see build and a bit of a pullback throughout each quarter of 2014 but the trend should be positive throughout the course of the year and if you see other geographies follow a similar patter, that would be beneficial as well.

Rajvinda Gill - Needham

And just last question on the automotive microcontroller business. What are your plans to gain share particularly in Japan? I know, in the past, we have talked about where you have nominal share there. Are you looking at opportunities to kind of exploit the Renesas/NEC merger that's been having some difficulties over the last couple of years? Thank you.

Gregg Lowe

We see Japan as a great opportunity for us and as a company that has four decades worth of automotive exposure and knowledge and so forth, we come at it with experience, we come at it with knowledge of how to handle the environment, both from a quality standpoint and from a temperature standpoint. Our teams are very, very focused to capitalize on the opportunity that we see in Japan and we are working that very, very hard. I am personally over there, quite a bit, working with customers and so forth and we are seeing some good signs. There is still a long ways to go but we are seeing some good signs for opportunity there.

Rajvinda Gill - Needham

Excellent. Thank you.

Mitch Haws

Okay. That does conclude today's call. We appreciate you joining us. We appreciate your ongoing interest in Freescale. Have a good evening.

Operator

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

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