Freescale Semiconductor's CEO Discusses Q1 2014 Results - Earnings Call Transcript

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 |  About: Freescale Semiconductor Inc. (FSL)
by: SA Transcripts

Freescale Semiconductor Inc. (NYSE:FSL)

Q1 2014 Earnings Conference Call

April 24, 2014 05:00 pm ET

Executives

Gregg Lowe – President & Chief Executive Officer

Alan Campbell – Senior Vice President & Chief Financial Officer

Mitch Haws – Investor Relations

Analysts

John Pitzer – Credit Suisse

William Stein – SunTrust, Robinson, Humphrey

Craig Hettenbach – Morgan Stanley

Ross Seymore – Deutsche Bank

Doug Freedman – RBC Capital Markets

Ruben Roy – Piper Jaffray

Operator

Welcome to Freescale’s Q1 2014 Results Conference Call. (Operator instructions.) Today’s call is being recorded. If anyone has any objections you may disconnect at this time. I will now turn the meeting over to Mitch Haws. Sir, you may begin.

Mitch Haws

Thanks, Kim, and welcome all of you to our Q1 2014 earnings call. With me today are Gregg Lowe, our President and Chief Executive Officer, and Alan Campbell, our CFO.

Before we begin the prepared remarks today I’d like to remind everyone that today’s discussion will contain 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 actual results to differ materially.

The company does not assume an obligation to update any forward-looking statements to reflect subsequent events or circumstances. Finally, during the course of the discussion today we will reference non-GAAP financial measures and on our website at www.freescale.com you’ll find the appropriate GAAP financial reconciliations.

With that I’ll turn the call over to Gregg.

Gregg Lowe

Thanks, Mitch, and good afternoon everybody. I’ll spend a couple of minutes highlighting our Q1 results after which Alan will provide some additional insight into the financials and provide our Q2 guidance. Following Alan’s comments we’ll take your questions.

Now, looking at the results, the performance in Q1 demonstrates that we’re continuing to make good progress on our goals of growing revenue to gain share and increasing gross margins. Looking at the quarter, revenues were $1.13 billion, ahead of the upper end of our guidance and 4% higher than Q4. This represents a 15% growth over Q1 of last year. All five product groups grew sequentially and all five showed double-digit growth compared to last year.

Gross margins were 44.8%, up 90 basis points from Q4, and adjusted earnings per share for Q1 were $0.27. So overall some good progress but there’s still plenty left for us to accomplish, and our entire team is focused on continuing improvements in market share and margins. And with that let me turn it over to Alan.

Alan Campbell

Yes, good afternoon again and thanks for joining today’s call. Looking at Q1, our revenues were $1.13 billion, 4% ahead of Q4 and 15% above Q1 of last year. As Gregg mentioned, revenues for our five core product groups grew 7% sequentially and 21% compared to Q1 last year. I’m going to go into some of the details for each product group.

Our microcontroller sales were up 1% from the last quarter above seasonality, and grew 26% compared to Q1 of last year. We continued to see strong growth in our 32-bit MCUs sold to both OEMs and distributors worldwide. In addition, sales of our application processors into the automotive and distribution channel grew year-over-year.

Digital Networking revenues grew 1% from prior quarter and grew 23% from the same period last year. Year-over-year Networking sales growth was broad based across service provider, enterprise, and general [and varied] segments. Sequentially the Networking business did benefit from higher sales of service provider equipment including wireless base stations in China. Our multi core revenues in Digital Networking doubled when compared to the same period last year.

Automotive microcontroller sales grew 14% sequentially and were up 20% compared to the same period last year. The business saw strong growth in all regions and in distributions due to growth in semi content and higher production levels.

Analog and Sensor sales were 4% ahead of the last quarter and 12% above Q1 of last year. The sequential and year-over-year growth was primarily due to increased semiconductor content in autos driven by fuel efficiency and safety feature requirements coupled with an increase in worldwide auto production.

RF sales grew 18% from Q4 and were up 31% ahead of Q1 last year. The increase in RF sales was due to growth in wireless infrastructure investment, particularly in China where demands for both [TBI CDME] and TDLTE were strong.

Other products, again which consist primarily of IP and the remaining cellular handset revenues declined 37% from Q4. Both IP and cellular revenues declined sequentially and year-over-year.

Finally, sales to our distribution grew 7% sequentially and were up 21% compared to the same period last year. During Q1 distribution inventory significantly reduced from a 9.1 weeks to 7.1 weeks. Recall that in early January we initiated the consolidation of our major distributors from three to two. We believe this will result in more resources dedicated to our products and greater field support as we continue to grow our business through the channel. Our book to bill for the company in Q1 was 1.07 and this compared to 1.04 in the last quarter.

Let me now turn to gross margins and operating expenses. Our gross margins were 44.8% as compared to the 43.9% in Q4. The 98 basis point sequential improvement resulted from ongoing operational efficiencies, utilization, and procurement savings. These improvements offset the impact of lower IP revenues and ASP adoptions associated with our annual pricing agreements with customers.

Compared to Q1 of last year, gross margins were up 430 basis points due primarily to higher utilization, higher sales along with cost reductions from the operating efficiencies and procurement savings. All these items more than offset the impact of the lower IP and annual price decreases.

Relative to gross margin we have transitioned seven personnel from roles focusing on (inaudible) portfolios and customer qualifications to roles supporting various new product development initiatives. These moves modestly benefited our gross margin compared to prior quarters while modestly increasing our R&D expense. Our internal frontend factory utilization was approximately 90% in Q1and this compares to the 86% in Q4 and the 82% in the same period last year.

I’ll move now to our operating expenses. Operating expenses as a percent of sales remained relatively flat from last quarter and last year. The absolute dollar expense increased both on a sequential and year-over-year basis. The increase is the result of increased incentive compensation, an IP settlement, an increase in spending and R&D as we continue expanding our product pipeline including the transition of resources referenced earlier.

Adjusted operating earnings were $186 million or 16.5% of sales. This compares favorably to the $174 million or 16.1% of sales last quarter and the 11.9% of sales in the same period last year.

Included in today’s results are $59 million of costs associated with debt redemption and refinancing transactions completed during the quarter. In total we refinanced approximately $2.7 billion in debt and retired approximately $680 million using proceeds from the February, 2014, equity offering. Beginning in Q2 these transactions will reduce our annualized interest expense by approximately [$7 million to $8 million] based on current interest rates. Importantly, all of our long-term debt now matures in 2020 or later.

Our adjusted net earnings in Q1 were $77 million exclusive of debt refinancing costs, reorganization charges, share-based compensation and other adjustments included in today’s earnings release. This compares against favorable adjusted earnings of $50 million in Q4 and a loss of $8 million in the same period last year.

Adjusted net earnings per share, exclusive of the adjustments I just mentioned, were $0.26 this compares to earnings per share of $0.19 in Q4 and an adjusted net loss per share of $0.03 in the same period last year.

Our EBITDA in Q1 was $244 million or 22% of sales, and this compares to $236 million in the last quarter and is well above the $178 million reported in the same period last year. Adjusted EBITDA was $949 million on a trailing twelve-month basis.

I will now turn to cash. Looking at cash, our cash and cash equivalents were $709 million. This compares to the $747 million in Q4 and our operating cash flow in Q1 was $26 million. This cash flow did include a payment for incentive compensation. It also included increased working capital associated with the incremental revenues and some change in payment terms to some of our customers, as well as cash costs associated with the debt financing.

Inventory dollars declined slightly from Q4, $9 million, and inventory days were 106 compared to the 110 in Q4. Excluding inventory related to the (inaudible) transition of days our inventory now stands at 102.

Our capital expenditure for the quarter of $56 million was 5% of sales. This was increased to recognize the increased assembly and test capacities associated with our growth in RF and microcontrollers. On a trailing twelve-month basis our CAPEX as a percent of sales was 4%. And given our consistent execution on managing cash we continue to have solid liquidity. Our cash and cash equivalents coupled with the undrawn revolver of approximately $400 million affords us the opportunity to continue to invest in the business, fund our capital expenditures and continue to de-lever.

I will now take a few minutes if I could to discuss Q2. Based on the current outlook we do expect Q2 revenues to be in the range of $1.14 billion to $1.20 billion. This revenue guidance implies at the high level our Digital Networking and RF revenues increase due to continued strength in wireless infrastructure, our microcontroller revenues increase sequentially given solid demand and trends in distribution in industrial markets. Our Automotive microcontroller revenues are anticipated to be flat to down modestly, and our analog sensor revenues will be in line with Q1.

Finally, we expect our gross margins to be up approximately 50 to 75 basis points sequentially. And with that I’d like now to turn the call back to Gregg.

Gregg Lowe

Well, thank you, Alan. As you saw in the press release issued earlier we have named Alan’s successor as Senior Vice President and CFO. Dan Durn, who was most recently at GLOBALFOUNDRIES as CFO will be joining Freescale starting in early June. Dan brings an extensive financial background to the role and we’re very pleased that he’s joined the Freescale team.

We extend a heartfelt thanks to Alan for his contributions to Freescale during his 34 years here, and on a personal note I’ll certainly miss Alan. He’s been a strong advocate for change at the company and a thought partner of mine as we drive Freescale in a new direction. His council, wisdom, humor and independence of thought have helped me form better strategies and make better decisions, and Alan has made me a better CEO – and for that I’m deeply indebted.

In closing, we continue to make progress. All five business groups grew sequentially and year-over-year and we expect another quarter of sales growth as we move into Q2. Based on the midpoint of our guidance for revenue we would grow nearly 14% in the first half of this year compared to the first half of 2013.

Margins are improving and we’re making the investments that will position us for the future. This includes investments in new products that drive organic growth and acquisitions such as the multicore communications processor business we acquired from Mindspeed.

Our improving market presence was highlighted at our recent technology forum or the FTF. Overall attendance at FTF was a record, with nearly 2400 customers, distributors and eco-partner systems in attendance. We announced a number of significant additions to our product portfolio. Our microcontroller group introduced the second generation of our ARM-based Kinetis K series providing increased 32-bit functionality.

Our Digital Networking group announced a new Layerscape II family of system on a chip communications processor and of course the Mindspeed acquisition referenced earlier. Our Automotive MCU group introduced the industry’s highest performance MCUs designed for automotive instrument clusters with premium graphics capability.

Our RF team announced products that will expand their presence into the industrial and medical markets; and our Analog and Sensors group announced a new intelligent battery sensor with MCU functionality and in-vehicle networking for charging and monitoring of battery functions in hybrid and electric vehicles.

During Q1 we continued to make improvements to our capital structure by completing several transactions that reduced leverage and interest expense. We’re well positioned in growth markets and our team remains well-aligned and focused, and well aware that there’s much more to be done.

We appreciate your support and look forward to sharing future successes with you, and at this point we’ll open the call to questions. Operator, if you would please open the call.

Question-and-Answer Session

Operator

Thank you. (Operator instructions.) And our first question comes from John Pitzer with Credit Suisse. Your line is open.

John Pitzer – Credit Suisse

Hi, good afternoon guys, Gregg and Alan. Thanks for letting me ask a question, and Alan, let me add my thanks and congratulations for the new part of your life coming forward. But Gregg, a little bit on the China wireless build-out. I’m just kind of curious – clearly strong strength in both Digital Networking and RF in the March quarter. I think actually RF is at an all-time high at least relative to the data that you’ve given us with the reclassification of revenue. It sounds like it’s going to continue to be pretty strong in the June quarter. I’m kind of curious as to how you think that business trends into the back half of the year.

Gregg Lowe

You know, I’ll start off and then have Mitch maybe give you a little more color. Obviously we saw a strong growth both sequentially and year-on-year in both of the segments that are associated with that. RF has a lot more exposure to that business were our Digital Networking parts of the business have exposure to that and parts are exposed to other, different markets as well.

It obviously grew strong in Q1 and we’re looking forward to some pretty nice growth in Q2 as well, but beyond that maybe I’ll just let Mitch go through his thoughts on that.

Mitch Haws

Yeah, John, this is Mitch. I think it’s really a carryover from a couple quarters. If you look back at Q4, at Q1 and the guidance into Q2 particularly for RF, given their large share in that part of the world and the fact that it’s LTE which lines up very well with the next generation of products – that’s been a real good book of business for us. It’s less apparent in Digital Networking because that revenue stream is more diverse but if you look at the numbers there was clearly a benefit into Q1 and I would expect a continued benefit in Q2 as well.

I think there’s demand left. You’ve heard other people in the supply chain talk about it, lots of base station capacity left. It may not mean that everything is linear quarter-to-quarter but I think there is good demand left, and as the last couple quarters show we’re very well leveraged in that cycle.

John Pitzer – Credit Suisse

Thanks Mitch, that’s helpful. And then, just on the gross margin guide for the June quarter, given where utilization was in March and given the sequential growth I would have expected to see maybe a little bit more gross margin upside. Can you just remind me of the puts and takes there, and as you think about from here to target how should we think about revenue levels needed to achieve target and kind of length of time to get to those targets?

Alan Campbell

Yeah, John, so let me give you a bit of color. First of all in Q1 we set guidance of 50 to 75 sequentially and we were up 90 basis points, so obviously we exceeded that guidance. And that was in a quarter where IP revenues were actually down. Our utilization was up but it was also the quarter where we had the annual BPAs. So I think relative to the elements of gross margin, we’ve talked a lot about operational efficiencies and procurement and the team really did perform well in Q1 and mitigated some of those other headwinds with IP and annual BPAs.

As we look forward we still have a lot of conviction associated with the gross margin. I would say first and foremost the operational efficiency is the highest opportunity for us. This is operational efficiency on both legacy and some of the new products that we really have opportunity (inaudible) procurement. Some utilization is still available although we’re at 90% which is hot. There’s still the opportunity to increase that perhaps up to 94%, 95%. And then there’s opportunities – we’re growing our business very well and (inaudible) control with a focus on distribution.

So all those elements give us confidence of continued progress. I think we should probably get ahead of ourselves here as well and say that we have previously mentioned that at the $11.75 per quarter revenues we should be in the high 40%s for [gross] margins and I think it’s fair to say we have accelerated most of the revenue in Q1 [for gains in Q2]. The margins will follow. We’ll not see a step function in the operational because it’s all about the portfolio but we still have a lot of conviction around the gross margin gains we’ll be getting.

Gregg Lowe

And John, maybe just to add additional color to that, recall the company has two objectives and all the variable compensation, incentive compensation associated with it – and the folks in the organization are driven by that. That is a top line revenue growth and margin expansion, so a lot of hard work on that second one across those operating efficiency levers that Alan had talked about.

John Pitzer – Credit Suisse

Thanks, that’s helpful, Gregg. And then guys, for my last question just clearly revenue beat in the March quarter, even though the top line beat you still had a book to bill that improved quarter-on-quarter – I think you said 1.07. I’m kind of curious, three weeks into Q2 has the booking pattern remained fairly robust? And given the book to bill in March how do I think about visibility for June guidance, what kind of turns do you need to see to hit the midpoint versus what you would expect to be a normal turns environment for a calendar Q2? Thank you.

Alan Campbell

Yeah, thanks again, John. I think as mentioned the book to bill of 1.07 for Q1, there’s not been a change in path or direction, new orders that’s deviated from that experience in Q1. So that’s good news. From an orders standpoint, we historically have seen a large amount of orders on the books as we enter into the quarter. There is churn with those orders but in general or directional I would say 80% to 85% of those orders can be on the books as we enter into the quarter. So we enter the quarter with quite a lot of conviction around the gains that we’ll get.

Gregg Lowe

And onto the last point I guess I would add to that, from a distribution standpoint, you heard the commentary that inventory in the channel is down pretty significantly from the 9.0’s to 7.1. And so we’re not facing any kind of headwind from inventory in the channel, either.

John Pitzer – Credit Suisse

Okay, thanks guys. Congratulations.

Gregg Lowe

Thank you.

Operator

And our next question comes from William Stein with SunTrust.

William Stein – SunTrust, Robinson, Humphrey

Great, thanks for taking my question. I’m hoping you can give us maybe a little bit more detail in terms of the update on distribution. We understand you consolidated from three to two and I think you’re getting more focus from a design win perspective, and but you’re also getting a lower portion of your sales from distribution than most of your peers. I wonder if you can talk about how that’s trending and how you expect it to trend going forward, and then similarly in the new effort in direct sales in China. You opened ten new sales offices last year and I’m wondering if you can update us on that initiative as well, thank you.

Gregg Lowe

Okay, very good. So we did consolidate our global distributors from three to two, and the purpose of that was to get more focus and actually more you know, kind of feet on the street if you will – more resources promoting and selling our parts through the remaining two distributors that we have.

We’ve had extensive reviews with those distributors, that has kicked off very, very strongly; and I’m very, very pleased with the momentum that we have relatively early on in the process. You know, those distributors were at our most recent Freescale Technology Forum- you heard what I said earlier about the 2400 customers and partners participating in that, a kind of all-time record and so forth. So we feel very, very good about that.

I think part of the reason we wanted to consolidate was to get more attention and be more important to the remaining two distributors and I think we accomplished that; and I think that gave those distributors the confidence then to say “We want to grow with Freescale and we like the program that you have,” and this is going to be an area where they’re going to invest. And so I think that has gone exceptionally well and I’m very, very pleased with that. We have ongoing reviews with those folks and I’m involved in those as well as their leadership, too, and I think so far, so good.

I think over time our sales through the channel will trend up. I think we want to, we have I can’t recall, 80 different, maybe 100 different sales offices throughout the world, and our distributors have easily five times that. And so we want to leverage that and have these channel partners and really go to market together with them. So I would anticipate that their ability to reach those smaller customers, those broader customers and so forth will be a benefit to us.

And I think the fact that our portfolio, especially in the general purpose microcontroller area has grown so significantly over the past two years, it’s also giving the distributors confidence that kind of the ammunition that they can take with the Freescale line is very powerful when you go attack that broader channel.

In terms of China we have opened the markets and basically we are now interacting with customers in ten new cities. I had a review on that in fact this morning to go through how we’re doing in those cities, what’s happening with design wins, what’s happening with revenue and what’s happening with our partnerships with our distributors in those new cities. So it isn’t so much we’re now taking anything direct. What we’re doing is we’re putting resources in these cities to then work with our distributor partners and drive engagement growth there.

And I would say that the early signs of progress are very, very positive. We’re really excited about that. We’ve got hundreds of new customers that weren’t customers of ours before and are customers of ours now. When I look at the distribution (inaudible), their sales growth is very positive, design win trends are positive. So we’re early in the game there but I think that move has been very, very well received.

William Stein – SunTrust, Robinson, Humphrey

Great, that helps, thank you.

Operator

Thank you, and our next question comes from Craig Hettenbach with Morgan Stanley.

Craig Hettenbach – Morgan Stanley

Yes, thank you. As you look across the microcontroller portfolio for 2014 can you give us a sense of relative growth expectations between some of the general purpose microcontrollers and automotive that you see?

Gregg Lowe

Well, general purpose microcontrollers had very, very strong growth in 2013. We were up significantly in 2013, almost 18% in 2013 and it really led our business. And Craig, this is the business that’s the most fragmented of our businesses, so that’s obviously very good. Now, kicking off 2014 we also grew pretty substantially – 26% year-on-year, and if you look at the midpoint of the guidance and you take a look at what Alan had talked about in terms of the microcontroller business being up in Q2 this year. Our year-end growth will still be very, very strong for the microcontroller business for the first half of this year.

I think what’s happening is customers really like the ecosystem that we’ve developed over decades. They love how we develop microcontrollers and now we’ve got a whole significant new offering for them. I think over the last couple of years we’re up several hundred microcontroller products that we can offer customers. And that breadth of the portfolio, the fact that a lot of that portfolio is sort of pin-compatible or architectural compatible and so forth is really giving us a significant push. So we’re really pleased with the results in 2013 on an annual basis and then obviously 2014 is off to a pretty good start.

Craig Hettenbach – Morgan Stanley

Okay, thanks for that. And as my follow-up on the digital networking side, outside of wireless infrastructure can you talk about trends you’re seeing in comm and what you’re thinking for Q2 and perhaps into Q3?

Mitch Haws

Craig, this is Mitch. Q3 is probably out further than I’d want to comment but if you look at digital networking year-on-year pretty broad-based growth if you look at all aspects of service provider, some of the general embedded and enterprise markets were all up year-on-year. Sequentially LTE deployments in China were the biggest driver on a sequential basis, Enterprise was a bit weaker. That probably gets incrementally better as you get into Q2. LTE spending, again we’ve referenced that before, it should be strong, so going into Q2 I would expect LTE as well as some better trends in enterprise to help digital networking on a sequential basis. And again that would represent very good year-on-year growth.

Gregg Lowe

And Craig, maybe just adding a little bit additional color onto that. Recall last year, 2013 multi-core was a pretty significant growth area for us. We grew the multi-core business I believe 140% last year, and it ended up representing about a third of our total digital networking business. So it’s actually sizable growth on a sizable base. So that business was up 140% last year on a year-on-year basis, and in Q1 this year our multi-core business compared to Q1 last year is up 100% basically. So continuing very, very strong growth, so we’re really excited about that – and that cuts across multiple different end segments as well.

Craig Hettenbach – Morgan Stanley

Got it, thanks for the color.

Gregg Lowe

Thank you.

Operator

And your next question comes from Ross Seymore at Deutsche Bank.

Ross Seymore – Deutsche Bank

Hi guys, before my question I just wanted to pass on the congratulations to Alan and welcome Dan – but to Alan, best of luck with your next move. You will definitely be missed on our side.

On my first question, it’s really on the gross margin side of things. It seems that the mix should be a positive that I would think would get you above that 50 to 75 basis points given the end market splits that you guided to directionally. And then the full revenue level that would get you to a high 40%s gross margin, it seems like you’re going to be very, very close to that just in your June quarter guide but I guess you’re technically above the midpoint of the 40%s but not really into the upper 40%s. Is there something I’m missing as to why the 50 to 75 basis points isn’t a bit conservative?

Alan Campbell

First of all thanks for the comments, I appreciate it. The mix issue is an important one and I think with the mix that we’re looking at we should see some favorable. As we’ve said before some of those [indices] are growing fast in the overall company and they have higher margins. This is a key issue that I think is not just a case of mix in Q2. It’s really important and we really do believe that the mix can help us longer-term also from the gross margin.

Distribution represents [25%] of our revenues and we do know that distribution margins tend to be higher in the OEMs, and a lot of what we’re seeing in terms of microcontroller growth is positive towards the mix in terms of margins. We haven’t seen all of it at this point but it’s kind of that all of our [indices] have been growing double digits so you don’t see as much impact. But that should help us out certainly going forward.

In terms of the [11.75 that we’ve kind of quoted] in the high 40%s, there’s absolutely no reason why the company will not or cannot achieve that type of margin. Candidly, if we look at the 11.75 we’re a lot closer to it to your point in Q2, and the reality of it is that revenue has been somewhat accelerated and has exceeded many expectations. The margins will follow and the margins will follow because a large part of it is in the operational efficiency, and that’s one of those steady-as-you-go type opportunities. As we are managing all the portfolio, improving test times, yields, working from [gold] to copper, you will not see an immediate step function but you will see a continued improvement. And those are all reasons we have a lot of conviction on the margin expansion.

Ross Seymore – Deutsche Bank

Great. I think my second question on the OPEX, what should we think about for OPEX both in the guide and then conceptually into the back half, Alan?

Alan Campbell

Yeah, so the OPEX first of all, that as a percent of sales we think will remain relatively flat both sequentially and year-over-year. The dollars did increase and the majority or a good portion of those dollars were associated with compensation. As we’ve discussed before we are targeting variable compensation to 18,000 employees and it’s based on revenue growth and margin. So as we look back and we think about 2012 we had zero compensation; in 2013 we increased. In 2014 we doubled but we’re still not staying at the optimum levels at this point. So we really expect to see the variable comp continue to increase and be aligned with revenue growth and margin expansion. In terms of our guidance, I think using the kind of same ratio as a percent of sales of 29.5% is probably reasonable from a guidance let’s say to [the year end].

Ross Seymore – Deutsche Bank

Great. And I guess my last one: you guys did some good moves on the balance sheet with an offering pay down, etc. Can you just talk about how you prioritize cash usage now and if there’s any dynamics that could cause you to accelerate repurchasing debt or delay it given the debt structure you currently have? Thanks.

Alan Campbell

Yeah, so it’s obviously a lot of work, and kudos to the team at Freescale on the transactions. We obviously did a $750 million equity offering in Q1 and that was closely followed by a 2.7% refinancing. Combining that it kind of represented a $70 million to $80 million reduction in interest. As we look at it we continue and we kind of mentioned before that we’ll always look at the economics and align the capital structure with those economics.

The priority though for the company is still to de-lever. So we’ll look at the economics with the continuation to de-lever. We do know that the business model is looking [good] from a cash standpoint and that excess cash can be used to de-lever.

Ross Seymore – Deutsche Bank

Great, thank you.

Operator

Thank you. Our next question comes from Doug Freedman with RBC Capital Markets.

Doug Freedman – RBC Capital Markets

Hi guys, thanks for taking my questions and I’ll echo the congratulations and we’ll miss you, Alan.

Alan Campbell

Thanks, Doug.

Doug Freedman – RBC Capital Markets

A lot of questions have been asked and answered but can you maybe give us a little bit of insight into how we think about you recognizing the IP revenues going forward? It’s been pretty volatile – is there any sort of guidance you can offer on the lumpiness?

Alan Campbell

This is one that historically has been very lumpy so it makes it difficult. I will say just to echo, restate what we’ve mentioned in the call that IP revenues did decline sequentially and emphasize again some of the work that we’ve done in gross margins from an operational standpoint to get an improvement. We’ve historically been looking at kind of a $30 million/quarter IP revenue. I think from where we stand and where we stand in the overall financial model we probably want to think about it slightly down, into the maybe $20 million/quarter but at the same time still bet on some of the financial metrics we’ve talked to.

Doug Freedman – RBC Capital Markets

Alright. If I could maybe a question, Gregg, for you in how the compensation packages are being structured in terms of how do you choose to pay the bonuses for the incentive bonuses, the variable comp to OPEX versus maybe doing a little bit more on the stock comp side? I did notice that stock comp did tick up this last quarter – how do you choose the mix there of where to go?

Gregg Lowe

I would say a stock-based compensation and the long-term incentive obviously has a pretty big swing relative to the bonus. So we do have that as a pretty significant portion of our overall plan. But basically the way we look at it is the way probably most companies do, which is we look at where the competitive environment is and we look at what our top competitors do; and we align the best practices and so forth. And so it really kind of looks at it from that perspective.

I think from an incentive bonus standpoint the company as Alan said didn’t pay any bonus in 2012 and you know, that’s not a good competitive situation. It may have been necessary for the company at the time but that’s not a long-term viable thing because people relay on multiple different things – they rely on salaries, they rely on long-term incentives, they rely on things like 401(k)s and retirement plans and things like that. But they also rely on bonuses.

So as we started performing we started paying out bonuses. As Alan mentioned last year if you look at the payout relative to target it was about 30%, maybe a little bit more than that. If you look at where we ended up in the year it’s more like a 50% kind of number. We’ll be slightly, if we continue performing in the first half of the year we’ll be slightly ahead of that but still below 100%.

So our goal is to continue aligning all of the employees’ incentives with our shareholders as well, and as we continue driving performance which in this context is top line revenue growth and margin expansion we’ll continue driving increases in the bonuses into variable compensation; and at some point we’ll hit the 100% of target and that’ll be great. And I think the employees will be happy and I think the shareholders will be happy as well.

Doug Freedman – RBC Capital Markets

Great, thanks for all that detail. If I could one last one on you mentioned you’re about 85% booked, where you have backlog coverage of about 85% I think is how you put it. What impact if any is that having on your lead times and are you seeing any stretching out of your lead times? How responsive have you been able to be?

Alan Campbell

I would say overall lead times have been very consistent with both prior quarters and prior years. So as a general statement I would say lead times have been okay. There are certain parts of our business and product portfolio that we have seen a slight increase in some of the lead times, and I’ll make reference to our RF business as an example. You know, it’s a business that grew 18% in the quarter and 31% year-on-year so that obviously puts demands on the lead times but overall we are holding lead times fairly consistent.

We are trying to be also proactive with the capital investment to ensure that these lead times keep in check. We did commit $56 million of capital in Q1 which is 5% of sales and that was to help with the growth in the lead times.

Doug Freedman – RBC Capital Markets

Great, and if I could again, congratulations and I hope you have enough of an overlap with Dan that you can teach him a little bit of your accent so that these calls sound similar going forward. Thanks guys.

Alan Campbell

I’ll try, yeah.

Operator

Thank you, and our last question comes from Ruben Roy of Piper Jaffray.

Ruben Roy – Piper Jaffray

Thank you. Gregg, I just wanted to return a little bit to the multi-core commentary that you made. Obviously some strong numbers coming up here after what I would think was a little bit of a late entry for Freescale, so it’s good to see. Do you have some insight for us into sort of how the design pipeline looks and what type of [TAM] you guys are going after with the products that you have out in market today on the multi-core side, please?

Gregg Lowe

Well thanks for the question, and you know, you mentioned a little bit late. The company was definitely late to multi-core. I think it was an issue that was identified a number of years ago and the team started working on it three, four years ago, and I think the team has really done a great job of kind of getting back into the game. So I really credit Tom and his team with good execution to get back in.

Obviously with the size of the business representing in 2013 a third of the Digital Networking business, so Digital Networking, let’s just call it plus or minus $1 billion. So this is a $300 million business that grew 140% year-on-year and continues to grow year-on-year. In Q1 it’s doubling from where it was last year. I think you can’t do that unless you have a pretty good design pipeline; it’s just impossible to grow like that. We’ve got lots of different customers that are ramping and we feel pretty good about that.

I think that doesn’t mean we’re satisfied, it doesn’t mean we’re resting; it doesn’t mean we’re slowing it down or anything like that. In fact the acquisition that Tom made gives him some nice new products kind of at the lower end, and these are products that are in the market today, have customers, have revenue but have a really tiny sales force. And so we’re taking those products, we’re putting them in the hands of our sales force. We’ve got pitch packs and all this stuff ready so that when we close we can kind of hit the ground running.

So I would say that we’re pretty bullish on the multi-core as we look into 2014 and I think it’s going to be a good growth strategy for us for years to come.

Ruben Roy – Piper Jaffray

Thanks for that detail, Gregg. And just really quickly, Alan, I just wanted to make sure I understood this on the OPEX – so keep it you’re thinking around 29% of revenue is a good number for this year quarterly?

Alan Campbell

Yeah, I think that’s fair, Ruben – 29.0%, 29.5% is fair. It will be a function of revenue growth and margin for the [available comp] but 29.0% to 29.5% is doable.

Rubin Roy – Piper Jaffray

Got it, okay. Thank you very much guys.

Mitch Haws

Thanks. That concludes today’s call. We appreciate your interest in Freescale and we look forward to seeing you at conferences or other venues during the course of Q2. Thank you very much.

Operator

Thank you. This concludes today’s conference, you may disconnect at this time.

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