Attached files

file filename
EX-31.1 - CERTIFICATION OF CHIEF EXECUTIVE OFFICER - Freescale Semiconductor, Ltd.q2201510-qex311.htm
EX-32.1 - SECTION 1350 CERTIFICATION (CHIEF EXECUTIVE OFFICER) - Freescale Semiconductor, Ltd.q2201510-qex321.htm
EX-32.2 - SECTION 1350 CERTIFICATION (CHIEF FINANCIAL OFFICER) - Freescale Semiconductor, Ltd.q2201510-qex322.htm
EX-31.2 - CERTIFICATION OF CHIEF FINANCIAL OFFICER - Freescale Semiconductor, Ltd.q2201510-qex312.htm



 
 
 
 
 
 
 
 
 
 
 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 
 
 
 
 
 
 
FORM 10-Q
 
 
 
 
 
 
 
 
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended July 3, 2015
or
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from            to            
Commission File Number 001-35184
 
 
 
 
 
 
 
FREESCALE SEMICONDUCTOR, LTD.
(Exact name of registrant as specified in its charter)
 
 
 
 
 
 
 
BERMUDA
 
98-0522138
(Jurisdiction)
 
(I.R.S. Employer Identification No.)
6501 William Cannon Drive West
Austin, Texas
 
78735
(Address of principal executive offices)
 
(Zip Code)
(512) 895-2000
(Registrant’s telephone number)
 
 
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large Accelerated Filer
 
x
  
Accelerated Filer
 
¨
Non-Accelerated Filer
 
¨  (Do not check if a smaller reporting company)
  
Smaller reporting company
 
¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x
As of July 20, 2015 there were 310,982,797 shares of the registrant’s common shares outstanding.
 



Table of Contents
 

 
 
 
 
 
Page
Part I
Financial Information
 
Item 1.
Financial Statements (Unaudited):
 
Condensed Consolidated Statements of Operations for the Three and Six Months Ended July 3, 2015 and July 4, 2014
 
Condensed Consolidated Statements of Comprehensive Earnings for the Three and Six Months Ended July 3, 2015 and July 4, 2014
 
Condensed Consolidated Balance Sheets as of July 3, 2015 and December 31, 2014
 
Condensed Consolidated Statements of Cash Flows for the Six Months Ended July 3, 2015 and July 4, 2014
 
Notes to the Unaudited Condensed Consolidated Financial Statements
Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
Item 4.
Controls and Procedures
 
 
 
Part II
Other Information
 
Item 1.
Legal Proceedings
Item 1A.
Risk Factors
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
Item 3.
Defaults Upon Senior Securities
Item 4.
Mine Safety Disclosures
Item 5.
Other Information
Item 6.
Exhibits




PART I
Item 1. Financial Statements (Unaudited)
Freescale Semiconductor, Ltd.
Condensed Consolidated Statements of Operations
(Unaudited)
 
 
 
Three Months Ended
 
Six Months Ended
(in millions, except per share amounts)
 
July 3,
2015
 
July 4,
2014
 
July 3,
2015
 
July 4,
2014
Net sales
 
$
1,198

 
$
1,191

 
$
2,367

 
$
2,318

Cost of sales
 
622

 
654

 
1,238

 
1,276

Gross margin
 
576

 
537

 
1,129

 
1,042

Research and development
 
216

 
219

 
438

 
429

Selling, general and administrative
 
123

 
128

 
244

 
254

Amortization expense for acquired intangible assets
 
5

 
4

 
10

 
7

Reorganization of business, merger expenses and other
 
6

 
6

 
32

 
17

Operating earnings
 
226

 
180

 
405

 
335

Loss on extinguishment or modification of long-term debt
 
(9
)
 

 
(30
)
 
(59
)
Other expense, net
 
(71
)
 
(83
)
 
(149
)
 
(186
)
Earnings before income taxes
 
146

 
97

 
226

 
90

Income tax expense
 
24

 
11

 
34

 
27

Net earnings
 
$
122

 
$
86

 
$
192

 
$
63

 
 
 
 
 
 
 
 
 
Net earnings per share:
 
 
 
 
 
 
 
 
Basic
 
$
0.39

 
$
0.28

 
$
0.62

 
$
0.22

Diluted
 
$
0.38

 
$
0.28

 
$
0.61

 
$
0.21

Weighted average common shares outstanding:
 
 
 
 
 
 
 
 
Basic
 
310

 
303

 
308

 
291

Diluted
 
318

 
308

 
316

 
296

See accompanying notes.

3


Freescale Semiconductor, Ltd.
Condensed Consolidated Statements of Comprehensive Earnings
(Unaudited)

 
 
 
Three Months Ended
 
Six Months Ended
(in millions)
 
July 3,
2015
 
July 4,
2014
 
July 3,
2015
 
July 4,
2014
Net earnings
 
$
122

 
$
86

 
$
192

 
$
63

Other comprehensive earnings, net of tax:
 
 
 
 
 
 
 
 
Derivative instruments adjustments:
 
 
 
 
 
 
 
 
Unrealized gains (losses) arising during the period
 

 
3

 
(8
)
 
6

Reclassification adjustment for items in net earnings
 
3

 
1

 
6

 
2

Post-retirement adjustments:
 
 
 
 
 
 
 
 
Gains arising during the period
 
101

 

 
101

 

Amortization of actuarial (losses) gains in net earnings
 

 
(1
)
 
1

 
(1
)
Other comprehensive earnings
 
104

 
3

 
100

 
7

Comprehensive earnings
 
$
226

 
$
89

 
$
292

 
$
70

See accompanying notes.

4


Freescale Semiconductor, Ltd.
Condensed Consolidated Balance Sheets
 
(in millions)
 
July 3,
2015 (unaudited)
 
December 31,
2014
ASSETS
 
 
 
 
Cash and cash equivalents
 
$
588

 
$
696

Accounts receivable, net
 
560

 
562

Inventory, net
 
740

 
745

Other current assets
 
174

 
166

Total current assets
 
2,062

 
2,169

Property, plant and equipment, net
 
761

 
750

Intangible assets, net
 
55

 
59

Other assets, net
 
287

 
297

Total assets
 
$
3,165

 
$
3,275

 
 
 
 
 
LIABILITIES AND SHAREHOLDERS’ DEFICIT
 
 
 
 
Liabilities:
 
 
 
 
Current portion of long-term debt and capital lease obligations
 
$
35

 
$
35

Accounts payable
 
441

 
413

Accrued liabilities and other
 
329

 
397

Total current liabilities
 
805

 
845

Long-term debt
 
5,169

 
5,535

Other liabilities
 
364

 
476

Total liabilities
 
6,338

 
6,856

 
 
 
 
 
Shareholders’ deficit:
 
 
 
 
Preferred shares, par value $0.01 per share; 100 shares authorized, no shares issued and outstanding at July 3, 2015 and December 31, 2014
 

 

Common shares, par value $0.01 per share; 900 shares authorized, 311 and 305 issued and outstanding at July 3, 2015 and December 31, 2014, respectively
 
3

 
3

Additional paid-in capital
 
9,287

 
9,163

Treasury shares at cost
 
(8
)
 

Accumulated other comprehensive earnings (loss)
 
74

 
(26
)
Accumulated deficit
 
(12,529
)
 
(12,721
)
Total shareholders’ deficit
 
(3,173
)
 
(3,581
)
Total liabilities and shareholders’ deficit
 
$
3,165

 
$
3,275

See accompanying notes.

5


Freescale Semiconductor, Ltd.
Condensed Consolidated Statements of Cash Flows
(Unaudited)
 
 
Six Months Ended
(in millions)
 
July 3,
2015
 
July 4,
2014
Cash flows from operating activities:
 
 
 
 
Net earnings
 
$
192

 
$
63

Adjustments to reconcile net earnings to net cash provided by operating activities:
 
 
 
 
Depreciation and amortization
 
137

 
132

Reorganization of business, merger expenses and other
 
32

 
17

Share-based compensation
 
45

 
34

Excess tax benefits from share-based compensation plans
 
(25
)
 
(5
)
Deferred incomes taxes
 
21

 
7

Loss on extinguishment or modification of long-term debt, net
 
30

 
59

Other non-cash items
 
8

 
3

Changes in operating assets and liabilities:
 
 
 
 
Accounts receivable, net
 
3

 
(200
)
Inventory, net
 
10

 
47

Accounts payable and accrued liabilities
 
(71
)
 
34

Other operating assets and liabilities
 
(7
)
 
(47
)
Net cash provided by operating activities
 
375

 
144

 
 
 
 
 
Cash flows from investing activities:
 
 
 
 
Purchases of property, plant and equipment
 
(97
)
 
(112
)
Acquisitions and strategic investment activity
 
(10
)
 
(11
)
Payments for purchased licenses and other assets
 
(39
)
 
(44
)
Net cash used for investing activities
 
(146
)
 
(167
)
 
 
 
 
 
Cash flows from financing activities:
 
 
 
 
Retirements of and payments for long-term debt and capital lease obligations (1)
 
(394
)
 
(1,333
)
Debt issuance proceeds, net of debt issuance costs (1)
 

 
590

Proceeds from equity offering, net of offering costs
 

 
717

Proceeds from stock option exercises and ESPP share purchases
 
51

 
39

Excess tax benefits from share-based compensation plans
 
25

 
5

Payments for contractual arrangements
 
(2
)
 

Purchases of treasury shares
 
(8
)
 

Net cash (used for) provided by financing activities
 
(328
)
 
18

 
 
 
 
 
Effect of exchange rate changes on cash and cash equivalents
 
(9
)
 
2

Net decrease in cash and cash equivalents
 
(108
)
 
(3
)
Cash and cash equivalents, beginning of period
 
696

 
747

Cash and cash equivalents, end of period
 
$
588

 
$
744

 
 
 
 
 
(1) As discussed in the Annual Report, Freescale Inc. issued a $2.7 billion term loan in the first quarter of 2014, of which $2.1 billion was a non-cash exchange with existing lenders and is not reflected in the above presentation.
See accompanying notes.

6


Freescale Semiconductor, Ltd.
Notes to the Unaudited Condensed Consolidated Financial Statements
(Dollars in millions, except as noted)
(1) Overview and Basis of Presentation
Overview: Freescale Semiconductor, Ltd. (“Freescale Ltd.”), based in Austin, Texas, is a global leader in microcontrollers ("MCUs") and digital networking processors, commonly referred to as embedded processors. Embedded processors are the backbone of electronic systems, providing essential control, intelligence and security, while enhancing performance and power efficiency. We combine our embedded processors with our complementary analog, sensor and radio frequency ("RF") devices, as well as a full suite of software and design tools, to provide highly integrated embedded processing solutions that streamline customer development efforts, lower their costs and shorten their time to market.
A number of trends are driving growth in our end markets, including advances in automotive safety and electronics, the expansion of cloud computing, the proliferation of low-power, energy-efficient control devices, the build-out of next generation communications infrastructure, and the Internet of Things, an emerging network of smart devices designed to help make our lives safer and more productive. Our product and strategic focus is to serve the need for increased connectivity and enhanced intelligence critical to fast growing semiconductor applications while keeping the connection secure. Our business is organized around five principal product groups: Microcontrollers, Digital Networking, Automotive MCU, Analog & Sensors, and RF. We provide our customers secure embedded processing solutions along with complementary devices for the automotive, networking, industrial and consumer end markets.
We have a heritage of innovation and product leadership spanning more than 50 years that has resulted in an extensive intellectual property portfolio. We leverage our intellectual property portfolio, deep customer relationships built over many years of close collaboration, extensive suite of software and design tools and technical expertise to introduce innovative new products and platform-level solutions for our target markets. We believe our ability to leverage our intellectual property across product lines and target markets enables us to be early to market with many of our products. As a result, we have established leadership positions in many of our core markets. We sell our products directly to original equipment manufacturers, distributors, original design manufacturers and contract manufacturers. Freescale Ltd. and its wholly-owned subsidiaries, including Freescale Semiconductor, Inc. (“Freescale Inc.”), are collectively referred to as the “Company,” “Freescale,” “we,” “us” or “our,” as the context requires.
Proposed Merger: On March 1, 2015, Freescale Ltd. entered into an Agreement and Plan of Merger (the “Merger Agreement”), by and among Freescale, NXP Semiconductors N.V., a Dutch public limited liability company (“NXP”), and Nimble Acquisition Limited, a Bermuda exempted limited liability company and a wholly-owned, indirect subsidiary of NXP (“Merger Sub”). Pursuant to the terms of the Merger Agreement, Merger Sub will be merged with and into Freescale (the “Proposed Merger”), with Freescale surviving the Proposed Merger as a wholly-owned, indirect subsidiary of NXP. At the effective time of the Proposed Merger, pursuant to the terms of the Merger Agreement, each issued and outstanding share of Freescale common stock, other than treasury shares held by Freescale or shares owned by NXP or its subsidiaries, will be cancelled and automatically converted into the right to receive $6.25 per share in cash, without interest, plus 0.3521 of an authorized, issued and fully paid ordinary share of NXP, par value EUR 0.20 per share. NXP intends to fund the cash portion of the merger consideration with a combination of cash on hand and fully-committed debt financing and also intends to refinance certain of Freescale Inc.’s existing debt with fully-committed debt financing. On July 2, 2015, shareholders of Freescale Ltd. and NXP independently approved the Proposed Merger. Pending satisfaction of other customary closing conditions, including foreign regulatory approvals, the Proposed Merger is currently expected to close in the second half of 2015.
The Merger Agreement contains certain termination rights for Freescale and NXP, including if the Proposed Merger is not consummated before March 1, 2016, subject to certain extension rights. Upon termination of the Merger Agreement under specified circumstances, NXP or Freescale will be required to pay the other party termination fees of up to $600 million.
During the second quarter and first half of July 3, 2015, Freescale recorded expenses of $8 million and $14 million, respectively, consisting primarily of legal costs, retention incentives and dedicated resources associated with the Proposed Merger in the Condensed Consolidated Statement of Operations.
Basis of Presentation: The accompanying condensed consolidated financial statements for Freescale Ltd. as of July 3, 2015 and December 31, 2014, and for the three and six months ended July 3, 2015 and July 4, 2014 are unaudited, with the December 31, 2014 amounts included herein derived from the audited consolidated financial statements. In the opinion of management, these unaudited condensed consolidated financial statements include all adjustments (consisting of normal recurring adjustments and reclassifications) necessary to present fairly the financial position, results of operations and cash flows as of July 3, 2015 and for all periods presented. Certain amounts reported in previous periods have been reclassified to conform to the current period presentation.
Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP) have been omitted. These condensed

7


consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in our December 31, 2014 Annual Report on Form 10-K filed with the Securities and Exchange Commission on February 6, 2015 (the "Annual Report"). The results of operations for the three and six months ended July 3, 2015 are not necessarily indicative of the operating results to be expected for the full year.
The preparation of financial statements in conformity with U.S. GAAP requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of net sales and expenses during the reporting period. Actual results could differ from those estimates. In addition to the items described below, our significant accounting policies and critical estimates are disclosed in our Annual Report. Refer to “Critical Accounting Policies and Estimates” within “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report for more information.
Recent Accounting Pronouncements: In May 2014, the FASB issued Accounting Standards Update (“ASU”) No. 2014-09, “Revenue from Contracts with Customers” (Topic 606), which supersedes the revenue recognition requirements in ASC Topic 605, “Revenue Recognition,” and most industry-specific guidance. This ASU is based on the principle that revenue is recognized to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The ASU also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments, and assets recognized from costs incurred to obtain or fulfill a contract. The amendments in the ASU must be applied using either the retrospective or cumulative effect transition method and are effective for annual and interim periods beginning after December 15, 2017. Early adoption is not permitted. We are evaluating the effects, if any, adoption of this guidance will have on our consolidated financial statements.
(2) Other Financial Data
Statements of Operations Supplemental Information
Loss on Extinguishment or Modification of Long-Term Debt
During the second quarter and first half of 2015, we recorded charges totaling $9 million and $30 million, respectively, in the Condensed Consolidated Statements of Operations associated with debt redemptions that occurred during the first and second quarters of 2015. These charges consisted of call premiums and the write-off of unamortized debt issuance costs associated with the extinguished debt in accordance with ASC Subtopic 470-50, “Modifications and Extinguishments” (“ASC Subtopic 470-50”). (Refer to Note 4, “Debt,” for discussion of these transactions.)
During the first half of 2014, we recorded charges of $59 million in the Condensed Consolidated Statement of Operations associated with the extinguishment of debt and the amendments to our senior secured credit facilities. These charges consisted of call premiums, the write-off of unamortized debt issuance costs and original issue discount ("OID") associated with the extinguished debt and other expenses not eligible for capitalization in accordance with ASC Subtopic 470-50.
Other Expense, Net
The following table displays the amounts comprising other expense, net in the Condensed Consolidated Statements of Operations:
 
 
Three Months Ended
 
Six Months Ended
 
July 3,
2015
 
July 4,
2014
 
July 3,
2015
 
July 4,
2014
Interest expense
$
(73
)
 
$
(85
)
 
$
(152
)
 
$
(190
)
Interest income
1

 
3

 
2

 
6

Interest expense, net
(72
)
 
(82
)
 
(150
)
 
(184
)
Other, net
1

 
(1
)
 
1

 
(2
)
Other expense, net
$
(71
)
 
$
(83
)
 
$
(149
)
 
$
(186
)
Cash paid for interest was $83 million and $169 million during the second quarter and first half of 2015, respectively, and $71 million and $195 million during the second quarter and first half of 2014, respectively. Cash paid for interest in the first half of 2015 and 2014 included $3 million and $11 million, respectively, of accrued interest paid in connection with debt redemption transactions completed in those periods.
Net Earnings Per Share
We calculate earnings per share ("EPS") in accordance with ASC Topic 260, “Earnings per Share,” using the treasury stock method. Basic EPS is computed based on the weighted average number of common shares outstanding and unissued

8


shares underlying vested restricted share units ("RSUs") during the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common shares were exercised or converted into common shares or resulted in the issuance of common shares that then shared in the net earnings of the Company. During both the second quarter and first half of 2015, less than 1 million and during the second quarter and first half of 2014, approximately, 10 million and 12 million, respectively, of the Company’s stock options, RSUs and a warrant were excluded from the calculation of diluted EPS, because the inclusion of these awards would have been anti-dilutive. These awards could be dilutive in the future if the average estimated fair value of the common shares increases and becomes greater than both the exercise price of these awards and the number of assumed repurchases of shares under the treasury stock method.
During the second quarter of 2015, we issued an aggregate of 843 thousand shares of our common stock to our largest shareholder, Freescale Holdings L.P. ("Freescale L.P.") upon the net exercise of a warrant held by Freescale L.P. As this was a net exercise, no cash was paid upon exercise.
The following is a reconciliation of the numerators and denominators of the basic and diluted net earnings per common share computations for the periods presented:
 
 
 
Three Months Ended
 
Six Months Ended
(in millions, except per share amounts)
 
July 3,
2015
 
July 4,
2014
 
July 3,
2015
 
July 4,
2014
Basic net earnings per share:
 
 
 
 
 
 
 
 
Numerator:
 
 
 
 
 
 
 
 
Net earnings
 
$
122

 
$
86

 
$
192

 
$
63

Denominator:
 
 
 
 
 
 
 
 
Weighted average common shares outstanding (1) 
 
310

 
303

 
308

 
291

Basic net earnings per share
 
$
0.39

 
$
0.28

 
$
0.62

 
$
0.22

Diluted net earnings per share:
 
 
 
 
 
 
 
 
Numerator:
 
 
 
 
 
 
 
 
Net earnings
 
$
122

 
$
86

 
$
192

 
$
63

Denominator:
 
 
 
 
 
 
 
 
Number of shares used in basic computation (1)
 
310

 
303

 
308

 
291

Add: Incremental shares for dilutive effect of warrants (2)
 

 

 

 

Add: Incremental shares for dilutive effect of stock options (3)
 
3

 
2

 
3

 
2

Add: Incremental shares for dilutive effect of unvested RSUs (4)
 
5

 
3

 
5

 
3

Adjusted weighted average common shares outstanding
 
318

 
308

 
316

 
296

Diluted net earnings per share
 
$
0.38

 
$
0.28

 
$
0.61

 
$
0.21

 
(1)
Weighted average common shares outstanding includes outstanding common shares of the Company and unissued common shares underlying vested RSUs.
(2)
A warrant to purchase an aggregate of 10 million common shares at $36.12 per share was net exercised on May 7, 2015 at a market price of $39.62 and 843 thousand common shares were issued. During the second quarter and first half of 2014, the warrant was not included in the computation of diluted EPS because the warrant's exercise price was greater than the average fair market value of the common shares during those periods.
(3)
Stock options to purchase an aggregate of less than 1 million common shares that were outstanding during both the second quarter and first half of 2015 and less than 1 million and 2 million during the second quarter and first half of 2014, respectively, were anti-dilutive and were not included in the computation of diluted EPS because the exercise price was greater than the average fair market value of the common shares, and the number of shares assumed to be repurchased using the proceeds of unrecognized compensation expense, potential windfall tax benefits and exercise prices was greater than the weighted average number of shares underlying outstanding stock options.
(4)
Unvested RSUs, of less than 1 million that were outstanding during the second quarter and first half of 2015 were anti-dilutive and were not included in the computation of diluted EPS, because the number of shares assumed to be repurchased using the proceeds of unrecognized compensation expense and potential windfall tax benefits was greater than the weighted average number of outstanding unvested RSUs. There were no unvested RSUs that were anti-dilutive during the second quarter or first half of 2014.

9


Balance Sheets Supplemental Information
Inventory, Net
Inventory, net consisted of the following:
 
 
July 3,
2015
 
December 31,
2014
Work in process and raw materials
$
517

 
$
517

Finished goods
223

 
228

Inventory, net
$
740

 
$
745

As of July 3, 2015 and December 31, 2014, we had $58 million and $62 million, respectively, in reserves for inventory deemed obsolete or in excess of forecasted demand and for any inventory where cost exceeds the estimated net realizable value. If actual future demand or market conditions are less favorable than those projected by our management, additional inventory write-downs may be required.
Property, Plant and Equipment, Net
Depreciation and amortization expense was $43 million and $86 million during the second quarter and first half of 2015, respectively, and $42 million and $85 million during the second quarter and first half of 2014, respectively. Accumulated depreciation and amortization was $2,888 million and $2,837 million at July 3, 2015 and December 31, 2014, respectively.
Accumulated Other Comprehensive Loss
 
 
Unrealized
Losses on
Derivatives
 
Unrealized
(Losses) Gains on
Post-retirement
Obligations
 
Foreign Currency
Translation
 
Total
Balance at January 1, 2015
$
(26
)
 
$
(19
)
 
$
19

 
$
(26
)
Current period net change
(2
)
 
102

 

 
100

Balance at July 3, 2015
$
(28
)
 
$
83

 
$
19

 
$
74

Post-retirement Health Care Benefits
During the second quarter of 2015, the Company communicated an amendment to the Post-retirement Healthcare Plan. Starting January 1, 2016, benefits under the plan to participants over the age of 65 are paid to a retiree health reimbursement account instead of directly providing health insurance coverage to the participants. These participants will be able to use the fixed annual subsidy they receive through this account toward the purchase of their own health care coverage from private insurance companies and for reimbursement of eligible health care expenses. This change resulted in a re-measurement of the plan during the second quarter of 2015, which reduced the net liability by $101 million and generated deferred prior service costs recorded within accumulated other comprehensive earnings of $101 million, net of taxes. The deferred prior service cost will be recognized over approximately 16 years, which is the period which the remaining eligible employees eligible for the plan will qualify for benefits under the plan.
(3) Fair Value Measurement
Fair value is defined as the exit price, or the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants as of the measurement date. Authoritative guidance establishes a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available. Observable inputs are market inputs participants would use in valuing the asset or liability and are developed based on market data obtained from independent sources. Unobservable inputs are inputs that reflect management's assumptions about the factors market participants would use in valuing the asset or liability. The guidance establishes three levels of inputs that may be used to measure fair value:
Level 1 – quoted prices in active markets for identical assets or liabilities;
Level 2 – quoted prices for similar assets and liabilities in active markets or inputs that are observable; and,
Level 3 – inputs that are unobservable (for example, cash flow modeling inputs based on assumptions).
Assets and Liabilities Measured and Recorded at Fair Value on a Recurring Basis
We measure cash and cash equivalents, derivative contracts and certain other assets and liabilities, as required, at fair value on a recurring basis. The tables below set forth, by level, the fair value of these assets and liabilities as of July 3, 2015 and December 31, 2014. The table does not include assets and liabilities which are measured at historical cost or on any basis other than fair value. In the first halves of both 2015 and 2014, there were no transfers between Level 1 and Level 2. We had no Level 3 instruments at July 3, 2015 or December 31, 2014.

10


 
 
 
 
 
Quoted Prices
in Active
Markets for
Identical Assets
 
Significant
Other
Observable
Inputs
As of July 3, 2015
Total    
 
(Level 1)
 
(Level 2)
Assets
 
 
 
 
 
Time deposits (1)
$
101

 
$
101

 
$

Money market mutual funds (1)
7

 
7

 

Foreign currency derivative contracts (2)
5

 

 
5

Interest rate swap agreements (3)
1

 

 
1

Total assets
$
114

 
$
108

 
$
6

Liabilities
 
 
 
 
 
Foreign currency derivative contracts (2)
$
12

 
$

 
$
12

Interest rate swap agreements (3)
22

 

 
22

Commodity derivative contracts (4)
1

 

 
1

Total liabilities
$
35

 
$

 
$
35

 
 
 
 
Quoted Prices
in Active
Markets for
Identical Assets
 
Significant
Other
Observable
Inputs
As of December 31, 2014
Total    
 
(Level 1)
 
(Level 2)
Assets
 
 
 
 
 
Time deposits (1)
$
344

 
$
344

 
$

Money market mutual funds (1)
7

 
7

 

Foreign currency derivative contracts (2)
3

 

 
3

Interest rate swap agreements (3)
1

 

 
1

Total assets
$
355

 
$
351

 
$
4

Liabilities
 
 
 
 
 
Foreign currency derivative contracts (2)
$
19

 
$

 
$
19

Interest rate swap agreements (3)
13

 

 
13

Commodity derivative contracts (4)
1

 

 
1

Total liabilities
$
33

 
$

 
$
33

The following footnotes indicate where the noted items are reported in our Condensed Consolidated Balance Sheets at July 3, 2015 and December 31, 2014:
(1)
Time deposits and money market mutual funds are reported as cash and cash equivalents. The decline in time deposits from December 31, 2014 to July 3, 2015 was attributable to the overall reduction in the target level of cash and cash equivalents as discussed in the Annual Report.
(2)
Foreign currency derivative contracts are reported as other current assets or accrued liabilities and other.
(3)
Interest rate swap arrangements are reported as current assets, accrued liabilities and other or other liabilities.
(4)
Commodity derivative contracts are reported as accrued liabilities and other.
Valuation Methodologies
In determining the fair value of our interest rate swap derivatives, we use the present value of expected cash flows based on market observable interest rate yield curves commensurate with the term of each instrument. For foreign currency and commodity derivatives, we use forward contract valuation models employing market observable inputs, such as spot and forward rates for currencies and commodities. Since we only use observable inputs in our valuation of our derivative assets and liabilities, they are considered Level 2. Refer to Note 5, “Risk Management,” for further information on our foreign currency and commodity derivative contracts and our interest rate swap agreements.
Fair Value of Other Financial Instruments
In addition to the assets and liabilities described above, our financial instruments also include accounts receivable, other investments, accounts payable, accrued liabilities and long-term debt. Except for the fair value of our long-term debt, which

11


was approximately $5,286 million, exclusive of $35 million of current maturities, at July 3, 2015, and approximately $5,568 million, exclusive of $35 million of current maturities, at December 31, 2014, the fair values of these financial instruments were not materially different from their carrying or contract values on those dates. The fair value of our long-term debt is considered a Level 1 input based on broker trading prices in active markets.
(4) Debt
The carrying value of our long-term debt at July 3, 2015 and December 31, 2014 consisted of the following:
 
 
July 3,
2015
 
December 31,
2014
Amended 2020 Term Loan
$
2,663

 
$
2,674

2021 Term Loan
779

 
783

2019 Revolver

 

Senior secured 5.00% notes due 2021
500

 
500

Senior secured 6.00% notes due 2022
960

 
960

Senior unsecured 10.75% notes due 2020
302

 
473

Senior unsecured 8.05% notes due 2020

 
180

Total debt
5,204

 
5,570

Less: current maturities
(35
)
 
(35
)
Total long-term debt
$
5,169

 
$
5,535

First and Second Quarter of 2015 Debt Redemption Transactions
On May 6, 2015, after the requisite notice period, Freescale Inc. redeemed $100 million principal amount of the senior unsecured 10.75% notes due 2020 (the "10.75% Unsecured Notes") and recorded a $9 million charge, reflective of call premiums and the write-off of unamortized debt issuance costs on the extinguished notes.
On February 9, 2015, after the requisite notice period, Freescale Inc. redeemed the remaining $180 million principal amount of the senior unsecured 8.05% notes due 2020 (the "8.05% Unsecured Notes") and $70 million principal amount of the 10.75% Unsecured Notes and recorded a $21 million charge, reflective of call premiums and the write-off of unamortized debt issuance costs on the extinguished notes.
Credit Facility
At July 3, 2015, Freescale Inc.’s senior secured credit facilities (the "Credit Facility") included (i) the senior secured term loan facility maturing in 2020 (the "Amended 2020 Term Loan"), (ii) the senior secured term loan facility maturing in 2021 (the "2021 Term Loan") and (iii) the revolving credit facility due on February 1, 2019 (the "2019 Revolver"), including letters of credit and swing line loan sub-facilities, with a committed capacity of $400 million. At July 3, 2015, the interest rate on the Amended 2020 Term Loan and the 2021 Term Loan was 4.25% and 5.00%, respectively. The available capacity under the 2019 Revolver was $384 million, as reduced by $16 million of outstanding letters of credit, and borrowings under the 2019 Revolver would bear interest at LIBOR plus 3.75%, with an effective interest rate of 3.94% as of July 3, 2015.
Amended 2020 Term Loan
At July 3, 2015, $2,680 million was outstanding under the Amended 2020 Term Loan, which will mature on March 1, 2020. The Amended 2020 Term Loan bears interest, at Freescale Inc.'s option, at a rate equal to a spread over either (i) a base rate equal to the higher of either (a) the prime rate of Citibank, N.A. or (b) the federal funds rate, plus one-half of 1%; or (ii) a LIBOR rate based on the cost of funds for deposit in the currency of borrowing for the relevant interest period, adjusted for certain additional costs. The third amended and restated credit agreement as of March 1, 2013 (the "Credit Agreement") governs the terms of the Credit Facility and based on our total leverage ratio, provides that the spread over LIBOR with respect to the Amended 2020 Term Loan is 3.25%, with a LIBOR floor of 1.00%. Under the Credit Agreement, Freescale Inc. is required to repay a portion of the Amended 2020 Term Loan in quarterly installments in aggregate annual amounts equal to 1% of the initial balance, or $27 million annually. At July 3, 2015, the Amended 2020 Term Loan was recorded on the Condensed Consolidated Balance Sheet at a $17 million discount which is subject to accretion to par value over the term of the loan using the effective interest method.
2021 Term Loan
At July 3, 2015, $785 million was outstanding under the 2021 Term Loan, which will mature on January 15, 2021. The 2021 Term Loan bears interest, at Freescale Inc.'s option, at a rate equal to a spread over either (i) a base rate equal to the higher of either (a) the prime rate of Citibank, N.A. or (b) the federal funds rate, plus one-half of 1%; or (ii) a LIBOR rate based on the cost of funds for deposit in the currency of borrowing for the relevant interest period, adjusted for certain additional costs. Based on our total leverage ratio, the Credit Agreement provides that the spread

12


over LIBOR with respect to the 2021 Term Loan is 3.75%, with a LIBOR floor of 1.25%. Under the Credit Agreement, Freescale Inc. is required to repay a portion of the 2021 Term Loan in quarterly installments in aggregate annual amounts equal to 1% of the initial balance, or $8 million annually. At July 3, 2015, the 2021 Term Loan was recorded on the Condensed Consolidated Balance Sheet at a $6 million discount which is subject to accretion to par value over the term of the loan using the effective interest method.
Senior Notes
Freescale Inc. had an aggregate principal amount of $1,762 million in senior notes outstanding at July 3, 2015, consisting of (i) $500 million of 5.00% senior secured notes due 2021 (the "5.00% Secured Notes"), (ii) $960 million of 6.00% senior secured notes due 2022 (the "6.00% Secured Notes"), and (iii) $302 million of 10.75% Unsecured Notes (collectively, the "Senior Notes"). With regard to these notes, interest is payable semi-annually in arrears as follows: (i) every May 15th and November 15th for the 5.00% Secured Notes; (ii) every May 15th and November 15th for the 6.00% Secured Notes; and (iii) every February 1st and August 1st for the 10.75% Unsecured Notes.
Indentures and Covenant Compliance
The Credit Agreement and the indentures governing Freescale Inc.'s senior secured and senior unsecured notes (the "Indentures") contain restrictive covenants that limit the ability of our restricted subsidiaries to, among other things, incur or guarantee additional indebtedness or issue preferred shares, pay dividends and make other restricted payments, impose limitations on the ability of our restricted subsidiaries to pay dividends or make other distributions, create or incur certain liens, make certain investments, transfer or sell assets, engage in transactions with affiliates, merge or consolidate with other companies or transfer all or substantially all of our assets. Under the Credit Agreement and Indentures, Freescale Inc. must comply with conditions precedent that must be satisfied prior to any borrowing.
On March 23, 2015, Freescale Inc. launched consent solicitations to approve amendments to, and to waive certain provisions of, the indentures governing its 5.00% Secured Notes and 6.00% Secured Notes at the request and expense of NXP pursuant to the Merger Agreement. After the receipt of the required consents, on April 2, 2015 (the “Effective Date”), Freescale Inc. entered into (i) a supplemental indenture, by and among Freescale Inc., the guarantors named therein and The Bank of New York Mellon Trust Company, N.A., as trustee (the “2021 Trustee”), to the indenture dated as of May 31, 2013 (the “2021 Indenture”), by and among Freescale Inc., the guarantors named therein and the 2021 Trustee, governing the 5.00% Secured Notes, and (ii) a supplemental indenture, by and among Freescale Inc., the guarantors named therein and Wells Fargo Bank, National Association, as trustee (together with the 2021 Trustee, the “Trustees”), to the indenture dated as of November 1, 2013 (together with the 2021 Indenture, the “Supplemental Indentures”), by and among Freescale Inc., the guarantors named therein and the 2022 Trustee, governing the 6.00% Secured Notes (together with the 5.00% Secured Notes, the “Secured Notes”).
The Supplemental Indentures, among other things, (i) waive the right of holders of the Secured Notes to require Freescale to repurchase such holder’s Secured Notes as a result of the change of control resulting from the Proposed Merger, (ii) align the restricted group subject to the covenants in the indentures governing the Secured Notes with the restricted group subject to the covenants in the indentures governing existing NXP notes, and (iii) align certain other provisions of the indentures governing the Notes with the terms of the indentures governing existing NXP notes. The waivers became effective and operative as of the Effective Date. The amendments became effective as of the Effective Date, but will not become operative until the completion of the Proposed Merger. The cash payment in connection with the solicitations of consents will be made by NXP, or an agent on its behalf, after the satisfaction or waiver of the closing conditions to the Proposed Merger, and prior to the consummation of the Proposed Merger. If the cash payment is not made by the time of consummation of the Proposed Merger, the Supplemental Indentures will terminate upon written notice to the applicable Trustee by any noteholder entitled to receive such cash payment.
As of July 3, 2015, Freescale Inc. was in compliance with the covenants under the Credit Facility and the Indentures and met the total leverage ratio of 6.50:1 or lower, the senior secured first lien leverage ratio of 4.00:1 or lower and the fixed charge coverage ratio of 2.00:1 or greater but did not meet the consolidated secured debt ratio of 3.25:1 or lower. As of July 3, 2015, Freescale Inc.’s total leverage ratio was 3.92:1, senior secured first lien leverage ratio was 3.63:1, fixed charge coverage ratio was 4.49:1 and consolidated secured debt ratio was 4.12:1. Accordingly, we are currently restricted from incurring liens on assets securing indebtedness, except as otherwise permitted by the Indentures. The fact that we did not meet one of these ratios does not result in any default under the Credit Agreement or the Indentures.
Hedging Transactions
During 2014, we entered into cash flow designated interest rate swap agreements to hedge a portion of our variable rate debt against exposure to increasing LIBOR rates which may exceed the LIBOR floor on the Amended 2020 Term Loan in future periods. These agreements fix the interest rate on a portion of our variable rate debt beginning in 2016 and continuing through 2018. (Refer to Note 5, “Risk Management,” for further details of these hedging agreements.)
Debt Service
We are required to make debt service principal payments under the terms of our debt agreements. As of July 3, 2015, future obligated debt payments are $18 million during the remainder of 2015, $35 million in 2016, $35 million in 2017, $35

13


million in 2018, $35 million in 2019, $2,867 million in 2020 and $2,202 million thereafter. On July 6, 2015, Freescale Inc. delivered notice that it will redeem $302 million aggregate principal amount of the 10.75% Unsecured Notes, which constitutes all of the outstanding 10.75% Unsecured Notes, on August 5, 2015. Accordingly, an incremental $302 million of principal payments previously obligated in 2020 will be paid in the third quarter of 2015. We expect to record a charge of approximately $19 million in connection with this redemption, reflective of call premiums and the write-off of unamortized debt issuance costs, and will fund the redemption, inclusive of accrued and unpaid interest, using a combination of cash on hand and borrowings under the 2019 Revolver.
(5) Risk Management
Foreign Currency Risk
The functional currency for all of our foreign operations is the U.S. dollar. Accordingly, exchange rate gains and losses are recognized on transactions in currencies other than the U.S. dollar and included in operations for the period in which the exchange rates changed.
In order to reduce the exposure of our financial results resulting from fluctuations in exchange rates, our principal strategy has been to naturally hedge the foreign currency-denominated liabilities on our balance sheet against corresponding foreign currency-denominated assets, such that any changes in liabilities due to fluctuations in exchange rates are inversely offset by changes in their corresponding foreign currency assets. In order to further reduce our exposure to U.S. dollar exchange rate fluctuations, we have entered into foreign currency hedge agreements related to the currency and the amount of expenses we expect to incur in jurisdictions in which our operations are located. No assurance can be given that our hedging transactions will prevent us from incurring higher foreign currency-denominated costs when translated into our U.S. dollar-based accounts in the event of a weakening of the U.S. dollar on the non-hedged portion of our costs and expenses.
At July 3, 2015 and December 31, 2014, we had net outstanding foreign currency exchange contracts not designated as accounting hedges with notional amounts totaling approximately $120 million and $97 million, respectively, which are accounted for at fair value. These forward contracts have original maturities of three months or less. The fair value of the forward contracts was a net unrealized gain (loss) of less than $1 million and $(1) million at July 3, 2015 and December 31, 2014, respectively. Forward contract gains (losses) of less than $1 million and $(2) million for the second quarter and first half of 2015, respectively, and $1 million for both the second quarter and first half of 2014 were recorded in other expense, net in the Condensed Consolidated Statements of Operations related to our realized and unrealized results associated with these foreign exchange contracts. Management believes that these financial instruments will not subject us to undue risk of foreign exchange movements because gains and losses on these contracts should offset losses and gains on the assets and liabilities being hedged. The following table shows, in millions of U.S. dollars, the notional amounts of the most significant net foreign exchange hedge positions for outstanding foreign exchange contracts not designated as accounting hedges as of July 3, 2015 and December 31, 2014: 
Buy (Sell)
 
July 3,
2015
 
December 31,
2014
Malaysian Ringgit
 
$
45

 
$
32

Japanese Yen
 
$
27

 
$
5

Chinese Renminbi
 
$
18

 
$
30

Euro
 
$
7

 
$
9

Indian Rupee
 
$
4

 
$
4

`
Cash Flow Hedges
We use foreign currency exchange contracts to hedge future expected cash flows associated with net sales, cost of sales, research and development expenses and selling, general and administrative expenses. These forward contracts have original maturities of 16 months or less. The following table shows, in millions of U.S. dollars, the notional amounts of the foreign exchange hedge positions for outstanding foreign exchange contracts designated as cash flow hedges under ASC Topic 815, "Derivatives and Hedging," as of July 3, 2015 and December 31, 2014:

14


Buy (Sell)
 
July 3,
2015
 
December 31,
2014
 
Hedged Exposure
Malaysian Ringgit
 
$
88

 
$
93

 
Cost of sales
Chinese Renminbi
 
$
80

 
$
84

 
Cost of sales
 
 
$
22

 
$
21

 
Research and development
 
 
$
22

 
$
21

 
Selling, general and administrative
Japanese Yen
 
$
48

 
$
42

 
Cost of sales
 
 
$
13

 
$
16

 
Selling, general and administrative
Euro
 
$
(51
)
 
$
(39
)
 
Net sales
Indian Rupee
 
$
18

 
$

 
Research and development
Israeli Shekel
 
$
17

 
$

 
Research and development
At July 3, 2015 and December 31, 2014, we had cash flow designated forward contracts with a total fair value of net unrealized losses of $7 million and $15 million, respectively. Losses of $2 million and $5 million during the second quarter and first half of 2015, respectively, and $1 million during both the second quarter and first half of 2014, respectively, were recorded in the Condensed Consolidated Statements of Operations related to our realized results associated with these cash flow hedges. Management believes that these financial instruments will not subject us to undue risk of foreign exchange movements because gains and losses on these contracts should offset losses and gains on the forecasted expenses being hedged.
Interest Rate Risk
We use interest rate swaps to assist in mitigating the interest rate risk associated with the variable rate portion of our debt portfolio. During 2014, we entered into cash flow designated interest rate swap agreements that fix the interest rate on a portion of our variable rate debt beginning in 2016. We are required to pay the counterparties a stream of fixed rate interest payments at a weighted average rate of: (i) 1.62% on a notional amount of $1.4 billion in 2016, (ii) 2.43% on a notional amount of $1.1 billion in 2017 and (iii) 2.95% on a notional amount of $800 million in 2018. In connection with these interest rate swap agreements, we will receive variable rate payments from the counterparties based on 1-month LIBOR, subject to a LIBOR floor of 1%, which coincides with the LIBOR floor on the Amended 2020 Term Loan. The fair value of the interest rate swap agreements was an unrealized loss of $19 million and $9 million at July 3, 2015 and December 31, 2014, respectively. (Refer to Note 4, “Debt,” for further details of our variable rate indebtedness.)
Counterparty Risk
Outstanding financial derivative instruments expose us to credit losses in the event of nonperformance by the counterparties to the agreements. We also enter into master netting arrangements with counterparties when possible to mitigate credit risk in derivative transactions. A master netting arrangement may allow counterparties to net settle amounts owed to each other as a result of multiple, separate derivative transactions. The credit exposure related to these financial instruments is represented by the contracts with a positive fair value at the reporting date. On a periodic basis, we review the credit ratings of our counterparties and adjust our exposure as deemed appropriate. As of July 3, 2015, we believe that our exposure to counterparty risk is immaterial.
(6) Share and Equity-based Compensation
2011 Omnibus Incentive Plan
Non-qualified Options
During the first half of 2015, we granted approximately 1.6 million stock options under the 2011 Omnibus Incentive Plan, as amended and restated (the "2011 Plan"), to certain executives and employees. The majority of these stock options were granted on January 5, 2015 as part of the annual long-term incentive grant (the "2015 Annual Grant"). The awards granted in connection with the Annual Grant had a grant date fair value of $9.83 per share and an exercise price of $24.63 per share, which was equal to the stock price on January 5, 2015. Total compensation costs associated with the stock options under the 2015 Annual Grant was $12 million, net of estimated forfeitures.
Under the 2011 Plan, we have granted approximately 6.8 million non-qualified stock options in Freescale Ltd. (the “2011 Options”) with exercise prices ranging from $8.73 to $33.51 per share, to certain qualified participants, which remain outstanding as of July 3, 2015. The 2011 Options generally vest at a rate of 25% of the total grant on each of the first, second, third and fourth anniversaries of the date of grant and are subject to the terms and conditions of the 2011 Plan and related award agreements. As of July 3, 2015, we had approximately $30 million of unamortized expense, net of estimated forfeitures, which is being amortized on a straight-line basis over a period of four years to additional paid-in capital. The fair value of the 2011 Options was estimated on the date of grant using the Black-Scholes option pricing model. The assumptions used in the model are outlined in the following table:

15


 
Six Months Ended
 
July 3,
2015
 
July 4,
2014
Weighted average grant date fair value per share
$
9.87

 
$
6.83

Weighted average assumptions used:
 
 
 
Expected volatility
45.00
%
 
49.83
%
Expected lives (in years)
4.75

 
4.75

Risk free interest rate
1.54
%
 
1.41
%
Expected dividend yield
%
 
%
A summary of changes in the 2011 Options outstanding during the six months ended July 3, 2015 is presented below:
 
Stock Options
(in thousands)
 
Wtd. Avg.
Exercise Price
Per Share
 
Wtd. Avg.
Remaining
Contractual
Term (Years)
 
Aggregate
Intrinsic Value
(in millions)
Balance at January 1, 2015
6,987

 
$
14.28

 
5
 
$
76

Granted
1,598

 
$
24.72

 
 
 
 
Terminated, canceled or expired
(415
)
 
$
15.57

 

 
 
Exercised
(1,391
)
 
$
14.28

 

 
 
Balance at July 3, 2015
6,779

 
$
16.65

 
5
 
$
159

Exercisable options at July 3, 2015
1,715

 
$
13.07

 
5
 
$
46

The intrinsic value of options exercised under this plan during the first half of 2015 and 2014 was $33 million and $5 million, respectively.
Restricted Share Units
During the first half of 2015, we granted approximately 4.1 million RSUs to certain executives and employees under the 2011 Plan. Included in this amount were RSUs granted in connection with the 2015 Annual Grant with a grant date fair value of $24.63 per RSU and total compensation cost of $69 million, net of estimated forfeitures. RSUs generally vest at a rate of 25% of the total grant on the first, second, third and fourth anniversaries of the date of grant, or on another vesting schedule depending on the award, and are subject to the terms and conditions of the 2011 Plan and related award agreements. Also included in this amount were RSUs granted for retention of technical employees in connection with the Proposed Merger with a grant date fair value of $39.53 per RSU, total compensation cost of $15 million, net of estimated forfeitures, which vest 100% on the 18-month anniversary of the grant date. The expense associated with these retention RSUs is classified in reorganization of business, merger expenses and other in our Consolidate Statement of Operations. RSUs are not entitled to dividends or voting rights, if any, until the underlying common shares are delivered. The fair value of the RSU awards is recognized on a straight-line basis over the vesting period.
Also during the first half of 2015, we granted approximately 0.6 million performance-based RSUs ("TSR") to certain executives in connection with the 2015 Annual Grant. Each TSR, which cliff vests on the third anniversary of the date of grant, entitles the grant recipient to receive from 0 to 1.50 common shares for each of the target units awarded based on the relative total shareholder return of the Company's share price as compared to a set of peer companies. The Company estimates the fair value of the TSRs using a Monte Carlo valuation model, which includes a modifier for market results. The grant date fair value for the TSRs granted in connection with the 2015 Annual Grant was $25.87 per TSR, with a total compensation cost of $13 million, net of estimated forfeitures. TSRs are amortized on a straight-line basis over a period of 3 years to additional paid-in capital. The assumptions used in the Monte Carlo model, outside of projections of market results, are outlined in the following table:

16


 
Six Months Ended
 
July 3,
2015
 
July 4,
2014
Weighted average grant date fair value per share
$
25.87

 
$
15.98

Weighted average assumptions used:
 
 
 
Expected volatility
43.83
%
 
48.45
%
Expected lives (in years)
2.99

 
2.99

Risk free interest rate
1.06
%
 
0.80
%
Expected dividend yield
%
 
%
As of July 3, 2015 we had approximately $142 million of unamortized expense, net of expected forfeitures, which is being amortized on a straight-line basis to additional paid-in capital over a period of four years for RSUs and three years for TSRs and performance-based RSUs ("PRSUs"). Under the terms of the RSU, TSR and PRSU award agreements, common shares underlying these awards are issued to the participant upon vesting of the award based on the passage of time for the RSUs and based on both the passage of time and performance results for the TSRs and PRSUs.
A summary of changes in the RSUs, TSRs and PRSUs outstanding under the 2011 Plan during the six months ended July 3, 2015 is presented below:
 
RSUs, TSRs and PRSUs
(in thousands)
 
Wtd. Avg. Grant
Date Fair Value
Per Share
Non-vested RSU, TSR and PRSU balance at January 1, 2015
9,758

 
$
15.03

Granted
4,758

 
$
26.11

Issued
(2,433
)
 
$
15.01

Terminated, canceled or expired
(712
)
 
$
15.88

Non-vested RSU, TSR and PRSU balance at July 3, 2015
11,371

 
$
19.63

The weighted average grant date fair value of all RSUs and TSRs granted during the first half of 2015 and 2014 was $26.11 per share and $15.55 per share, respectively. The total intrinsic value of RSUs, TSRs and PRSUs issued under this plan during the first half of 2015 and 2014 was $83 million and $41 million, respectively.
The Company purchased $8 million of treasury shares during the first half of July 3, 2015 related to the withholding of common shares used to satisfy employee tax obligations in connection with the vesting of RSUs.
Employee Share Purchase Plan
Upon completion of our initial public offering in 2011, we initiated an Employee Share Purchase Plan (“ESPP”), as amended and restated during the annual shareholder's meeting on May 8, 2014, for which we have approximately 6.3 million remaining common shares reserved for future issuance. Under the ESPP, eligible participants are allowed to purchase common shares of Freescale through payroll deductions of up to 15% of their compensation on an after-tax basis. The price an employee pays per share is 85% of the fair market value of the common shares on the close of the last trading day of the purchase period. The ESPP has two six-month purchase periods, the first of which begins on January 1 and the second of which begins on July 1. On January 5, 2015, approximately 690 thousand common shares of Freescale were issued to participating employees under the ESPP for the second half of 2014 purchase period at a discounted price of $21.45 per share. On July 2, 2015, approximately 452 thousand common shares of Freescale were issued to participating employees under the ESPP for the first half of 2015 purchase period at a discounted price of $33.97 per share. During both the first half of 2015 and 2014, we recognized $3 million of compensation costs related to the 15% discount offered under this plan.
(7) Income Taxes
During the second quarter and first half of 2015, we recorded an income tax provision of $24 million and $34 million, respectively, which included income tax expense of $9 million and $12 million, respectively, associated with discrete events. The discrete expense in the second quarter and first half of 2015 was primarily related to an increase in the domestic valuation allowance resulting from the deferred tax asset created by the excess tax benefits from share-based awards during the period, partially offset by a benefit recognized in connection with tax laws changes in one of our foreign jurisdictions. The aforementioned excess tax benefits resulted from deductions related to equity compensation in excess of compensation recognized for financial reporting and were recorded in additional paid-in capital in accordance with ASC Subtopic 740, "Income Taxes" (“ASC Topic 740”).

17


For the second quarter and first half of 2014, we recorded an income tax provision of $11 million and $27 million, respectively, predominately related to our foreign operations which included $2 million and $6 million, respectively, of income tax expense primarily associated with discrete events related to an increase in the domestic valuation allowance resulting from the deferred tax asset created by the excess tax benefit from share-based awards.
Income taxes for the interim periods presented have been included in the condensed consolidated financial statements on the basis of an estimated annual effective tax rate. Our effective tax rate is impacted by the mix of earnings and losses by taxing jurisdictions. Although the Company is a Bermuda entity with a statutory income tax rate of zero, the earnings of many of the Company’s subsidiaries are subject to taxation in the U.S. and other foreign jurisdictions.
We incur minimal income tax expense on our U.S. earnings due to valuation allowances recorded on substantially all the Company’s U.S. net deferred tax assets. ASC Topic 740 requires that deferred tax assets be reduced by a valuation allowance if, based on all available evidence, it is considered more-likely-than-not that some portion or all of the recorded deferred tax assets will not be realized in a future period. Such assessment is required on a jurisdiction by jurisdiction basis. We have concluded that it is more-likely-than-not that our domestic deferred tax assets will not be realized in their entirety, and therefore, we have retained a valuation allowance against substantially all the domestic deferred tax assets. In our assessment of the need for a domestic valuation allowance, we heavily weighted the following negative evidence: (i) the U.S. Company has experienced a lack of historical operational profitability, exclusive of foreign intercompany dividends; (ii) the forecasted reversal of existing temporary differences does not create taxable income; and, (iii) the Company operates in a highly cyclical industry. In addition, we recorded valuation allowances in certain foreign jurisdictions after considering all positive and negative factors as to the recoverability of these assets. The valuation allowance on our U.S. deferred tax assets at July 3, 2015 was $1.1 billion. Any release of the valuation allowance will be recorded as a tax benefit increasing net earnings.
The Company does not expect the liability for unrecognized tax benefits to decrease substantially in the next twelve months. Certain of our income tax returns for the 2004 through 2013 tax years are currently under examination by various taxing authorities around the world. Although the resolution of open audits is highly uncertain, management considers it unlikely that the results of these examinations will have a material impact on our financial condition or results of operations.
(8) Commitments and Contingencies
Commitments
Product purchase commitments associated with strategic manufacturing relationships with our wafer foundries and for assembly and test services include take or pay provisions based on volume commitments for work in progress and forecasted demand based on 18-month rolling forecasts, which are adjusted monthly. The commitment under these relationships was $127 million as of July 3, 2015.
Litigation
We are a defendant in various lawsuits and are subject to various claims which arise in the normal course of business. The Company records an associated liability when a loss is probable and the amount is reasonably estimable.
From time to time, we are involved in legal proceedings arising in the ordinary course of business, including tort, contractual and customer disputes, claims before the United States Equal Employment Opportunity Commission and other employee grievances, and intellectual property litigation and infringement claims. Intellectual property litigation and infringement claims could cause us to incur significant expenses or prevent us from selling our products. Under agreements with Motorola Inc. ("Motorola"), Freescale Inc. must indemnify Motorola for certain liabilities related to our business incurred prior to our separation from Motorola in 2004.
Motorola has been named as a defendant in a number of suits filed in the Circuit Court of Cook County, Illinois alleging a link between working in semiconductor manufacturing clean room environments and birth defects in 49 individuals. Each of these suits seek an unspecified amount of damages in compensation for the alleged injuries. We have denied liability for these alleged injuries, and we are assessing the availability of applicable insurance coverage. In the first quarter of 2015, a trial was set for October 19, 2015 to determine liability and damages with respect to one of the 49 individuals. We do not believe an adverse judgment in this trial would have a material negative impact on our financial position, results of operations or cash flows. Although the outcome of litigation is inherently uncertain, based on the information currently available, we do not consider our liability for these matters to be probable or reasonably estimable at this time.
The resolution of intellectual property litigation may require us to pay damages for past infringement or to obtain a license under the other party's intellectual property rights that could require one-time license fees or ongoing royalties, require us to make material changes to our products and/or manufacturing processes, require us to cross-license certain of our patents and other intellectual property and/or prohibit us from manufacturing or selling one or more products in certain jurisdictions, which could adversely impact our operating results in future periods. If any of those events were to occur, our business, financial condition and results of operations could be adversely affected.

18


(9) Reorganization of Business, Merger Expenses and Other
Six months ended July 3, 2015
Strategic Realignment
We have continued to shift our research and development investment and sales force to accelerate growth and improve profitability (the "Strategic Realignment"). Since the inception of the plan in late 2012, we have recorded a total of $130 million in net charges to reorganization of business, merger expenses and other for employee termination benefits and other exit costs in connection with re-allocating research and development resources and re-aligning sales resources, as further described in this section.
At each reporting date, we evaluate our accruals for exit costs and employee separation costs, which consist primarily of termination benefits (principally severance payments), to ensure that our accruals are still appropriate. In certain circumstances, accruals are no longer required because of efficiencies in carrying out our plans or because employees previously identified for separation resign unexpectedly and do not receive severance or are redeployed due to circumstances not foreseen when the original plans were initiated. We reverse accruals to earnings when it is determined they are no longer required.
The following table displays a roll-forward from January 1, 2015 to July 3, 2015 of the employee separation and exit cost accruals established related to the Strategic Realignment:
(in millions, except headcount)
 
Accruals at
January 1, 2015
 
Charges
 
Adjustments
 
Usage
 
Accruals at
July 3, 2015
Employee Separation Costs
 
 
 
 
 
 
 
 
 
 
Supply chain
 
$
4

 
$
2

 
$
(1
)
 
$
(4
)
 
$
1

Research and development
 
13

 
15

 
(3
)
 
(19
)
 
6

Selling, general and administrative
 
7

 
2

 

 
(7
)
 
2

Total
 
$
24

 
$
19

 
$
(4
)
 
$
(30
)
 
$
9

Related headcount
 
375

 
315

 
(70
)
 
(490
)
 
130

During the first half of 2015, we incurred $19 million of additional employee separation charges related to the continued execution of this strategic plan. Additionally, we reversed $4 million of accruals for employees previously identified for separation who resigned unexpectedly and did not receive severance or were redeployed due to circumstances not foreseen when the original plans were initiated. The $30 million used reflects cash payments made to employees separated as part of the plan during the first half of 2015. The accrual of $9 million at July 3, 2015 reflects the estimated liability to be paid to the remaining 130 employees to be separated through 2016, along with previously separated employees still receiving severance benefits, based on current exchange rates.
Reorganization of Business Program
In 2008, we began executing a series of restructuring initiatives that streamlined our cost structure and re-directed some research and development investments into expected growth markets (the "Reorganization of Business Program"). Since the inception of the plan, we have recorded $244 million in net charges to reorganization of business, merger expenses and other. The only remaining actions relating to this reorganization program are the decommissioning of the land and buildings at our Toulouse, France manufacturing facility and payment of the remaining separation costs.
The following table displays a roll-forward from January 1, 2015 to July 3, 2015 of the employee separation cost accruals established related to the Reorganization of Business Program:
(in millions, except headcount)
 
Accruals at
January 1, 2015
 
Charges
 
Adjustments & Currency Impact
 
Usage
 
Accruals at
July 3, 2015
Employee Separation Costs
 
 
 
 
 
 
 
 
 
 
Supply chain
 
$
8

 
$

 
$
(1
)
 
$

 
$
7

Research and development
 
1

 

 

 

 
1

Total
 
$
9

 
$

 
$
(1
)
 
$

 
$
8

There were less than $1 million of cash payments made to employees separated as part of the Reorganization of Business Program during the first half of 2015. We adjusted our anticipated future severance payments by $1 million to incorporate the currency impact in the above presentation, reflecting the strengthening of the U.S. dollar against the Euro during the first half of 2015. The accrual of $8 million at July 3, 2015 reflects the estimated liability to be paid through 2015 to previously separated employees still receiving severance benefits and for outplacement services and other severance-related costs, based on current exchange rates.

19


Disposition Activities
During first half of 2015, we recorded $2 million in charges related to on-going closure and decommissioning costs for our Toulouse, France manufacturing facility. Additionally, during the first half of 2015, we incurred a $1 million charge associated with the liquidation of the remaining assets of one of our former foreign subsidiaries.
Merger Expenses
During first half of 2015, we recorded $14 million of expenses consisting primarily of legal costs, retention incentives and dedicated resources associated with the Proposed Merger.
Six months ended July 4, 2014
Strategic Realignment
The following table displays a roll-forward from January 1, 2014 to July 4, 2014 of the employee separation and exit cost accruals established related to the Strategic Realignment:
(in millions, except headcount)
Accruals at
January 1, 2014
 
Charges
 
Adjustments
 
Used
 
Accruals at
July 4, 2014
Employee Separation Costs
 
 
 
 
 
 
 
 
 
Supply chain
$
5

 
$
1

 
$

 
$
(4
)
 
$
2

Research and development
2

 
4

 

 
(3
)
 
3

Selling, general and administrative
4

 
3

 

 
(4
)
 
3

Total
$
11

 
$
8

 
$

 
$
(11
)
 
$
8

Related headcount
170

 
70

 

 
(150
)
 
90

Exit and Other Costs
$
8

 
$

 
$
(1
)
 
$
(3
)
 
$
4

During the first half of 2014, we incurred $8 million of additional employee separation charges related to the continued implementation of this strategic plan. The $11 million used reflects cash payments paid to employees separated as part of the Strategic Realignment during the first half of 2014.
Additionally, we recorded an adjustment of $1 million to our previously estimated cost to vacate underutilized office space in Austin, Texas in accordance with ASC Topic 420, "Exit or Disposal Cost Obligations," during the first quarter of 2014.
Reorganization of Business Program
The following table displays a roll-forward from January 1, 2014 to July 4, 2014 of the employee separation accruals established related to the Reorganization of Business Program:
(in millions, except headcount)
 
Accruals at
January 1, 2014
 
Charges
 
Adjustments & Currency Impact
 
Usage
 
Accruals at
July 4, 2014
Employee Separation Costs
 
 
 
 
 
 
 
 
 
 
Supply chain
 
$
17

 
$

 
$

 
$
(4
)
 
$
13

Research and development
 
1

 

 

 

 
1

Selling, general and administrative
 
1

 

 

 

 
1

Total
 
$
19

 
$

 
$

 
$
(4
)
 
$
15

Related headcount
 
30

 

 

 
(20
)
 
10

The $4 million used reflects cash payments made to employees separated as part of the Reorganization of Business Program during the first half of 2014 consisting of payments for severance benefits, outplacement services and other severance-related costs.
Disposition Activities
During the first half of 2014 and in connection with the closure of the Toulouse, France manufacturing facility, we recorded a $2 million charge related to on-going closure and decommissioning costs. We also recorded a charge of $4 million related to demolition costs incurred to prepare our former manufacturing facility located in Sendai, Japan for sale.
(10) Supplemental Guarantor Condensed Consolidating Financial Statements
Pursuant to the terms of our acquisition by a consortium of private equity funds (“Sponsors”) in a transaction referred to as the “Merger” in December 2006, Freescale Inc. continues as a wholly-owned indirect subsidiary of Freescale Ltd. The reporting entity subsequent to the Merger is Freescale Ltd.

20


As a result of the Merger and subsequent debt redemption and refinancing transactions, we had $1,762 million aggregate principal amount of Senior Notes outstanding as of July 3, 2015, as further discussed in Note 4, “Debt.” The senior secured notes are jointly and severally guaranteed on a secured, senior basis, and the senior unsecured notes are jointly and severally guaranteed on an unsecured, senior basis, and in each case, are subject to certain exceptions, by Freescale Ltd., its wholly owned direct and indirect subsidiaries created in connection with the Merger, and SigmaTel, LLC (together, the “Guarantors”). Each Guarantor fully and unconditionally guarantees, jointly and severally with the other Guarantors, as a primary obligor and not merely as a surety, the due and punctual payment and performance of the obligations. As of July 3, 2015, other than SigmaTel, LLC, none of Freescale Inc.’s domestic or foreign subsidiaries (“Non-Guarantors”) guarantee the Senior Notes or Credit Facility. In the future, other subsidiaries may be required to guarantee all or a portion of the Senior Notes, if and to the extent they guarantee the Credit Facility. (The relationship between the Company and the parent companies is defined and discussed in Note 1, “Basis of Presentation and Principles of Consolidation,” to our consolidated financial statements in the Annual Report.)
The following tables present our results of operations, financial position and cash flows of Freescale Ltd., the Guarantors, Freescale Inc., the Non-Guarantors and eliminations for the three and six months ended July 3, 2015 and July 4, 2014 and as of July 3, 2015 and December 31, 2014, to arrive at the information on a consolidated basis:
Supplemental Condensed Consolidating Statement of Operations
For the Three Months Ended July 3, 2015
(in millions)
Freescale Ltd.
 
Guarantors
 
Freescale Inc.
 
Non-Guarantors
 
Eliminations
 
Consolidated
Net sales
$

 
$

 
$
1,508

 
$
1,596

 
$
(1,906
)
 
$
1,198

Cost of sales

 

 
1,019

 
1,509

 
(1,906
)
 
622

Gross margin

 

 
489

 
87

 

 
576

Research and development

 

 
145

 
71

 

 
216

Selling, general and administrative
2

 

 
164

 
52

 
(95
)
 
123

Amortization expense for acquired intangible assets

 

 
5

 

 

 
5

Reorganization of business, merger expenses and other

 

 
15

 
(9
)
 

 
6

Operating (loss) earnings
(2
)
 

 
160

 
(27
)
 
95

 
226

Loss on extinguishment or modification of long-term debt

 

 
(9
)
 

 

 
(9
)
Other income (expense), net
195

 
195

 
56

 
98

 
(615
)
 
(71
)
Earnings before income taxes
193

 
195

 
207

 
71

 
(520
)
 
146

Income tax expense

 

 
10

 
14

 

 
24

Net earnings
$
193

 
$
195

 
$
197

 
$
57

 
$
(520
)
 
$
122



21


Supplemental Condensed Consolidating Statement of Comprehensive Earnings
For the Three Months Ended July 3, 2015
(in millions)
Freescale Ltd.
 
Guarantors
 
Freescale Inc.
 
Non-Guarantors
 
Eliminations
 
Consolidated
Net earnings
$
193

 
$
195

 
$
197

 
$
57

 
$
(520
)
 
$
122

Other comprehensive earnings, net of tax:
 
 
 
 
 
 
 
 
 
 
 
Derivative instruments adjustments:
 
 
 
 
 
 
 
 
 
 
 
Reclassification adjustment for items in net earnings

 

 
3

 

 

 
3

Post-retirement adjustments:
 
 
 
 
 
 
 
 
 
 
 
Gains arising during the period

 

 
101

 

 

 
101

Amortization of actuarial (losses) gains in net earnings

 

 
(1
)
 
1

 

 

Other comprehensive earnings

 

 
103

 
1

 

 
104

Comprehensive earnings
$
193

 
$
195

 
$
300

 
$
58

 
$
(520
)
 
$
226


Supplemental Condensed Consolidating Statement of Operations
For the Three Months Ended July 4, 2014
(in millions)
Freescale Ltd.
 
Guarantors
 
Freescale Inc.
 
Non-Guarantors
 
Eliminations
 
Consolidated
Net sales
$

 
$

 
$
1,526

 
$
1,588

 
$
(1,923
)
 
$
1,191

Cost of sales

 

 
1,041

 
1,536

 
(1,923
)
 
654

Gross margin

 

 
485

 
52

 

 
537

Research and development

 

 
143

 
76

 

 
219

Selling, general and administrative
2

 

 
164

 
58

 
(96
)
 
128

Amortization expense for acquired intangible assets

 

 
4

 

 

 
4

Reorganization of business, merger expenses and other

 

 
3

 
3

 

 
6

Operating (loss) earnings
(2
)
 

 
171

 
(85
)
 
96

 
180

Loss on extinguishment or modification of long-term debt

 

 

 

 

 

Other income (expense), net
175

 
175

 
5

 
98

 
(536
)
 
(83
)
Earnings before income taxes
173

 
175

 
176

 
13

 
(440
)
 
97

Income tax expense

 

 
1

 
10

 

 
11

Net earnings
$
173

 
$
175

 
$
175

 
$
3

 
$
(440
)
 
$
86



22


Supplemental Condensed Consolidating Statement of Comprehensive Earnings
For the Three Months Ended July 4, 2014
(in millions)
Freescale Ltd.
 
Guarantors
 
Freescale Inc.
 
Non-Guarantors
 
Eliminations
 
Consolidated
Net earnings
$
173

 
$
175

 
$
175

 
$
3

 
$
(440
)
 
$
86

Other comprehensive earnings, net of tax:
 
 
 
 
 
 
 
 
 
 
 
Derivative instrument adjustments:
 
 
 
 
 
 
 
 
 
 
 
Unrealized gains arising during the period

 

 
3

 

 

 
3

Reclassification adjustment for items in net earnings

 

 
1

 

 

 
1

Post-retirement adjustments:
 
 
 
 
 
 
 
 
 
 
 
Amortization of actuarial gains included in net earnings (loss)

 

 
(2
)
 
1

 

 
(1
)
Other comprehensive earnings

 

 
2

 
1

 

 
3

Comprehensive earnings
$
173

 
$
175

 
$
177

 
$
4

 
$
(440
)
 
$
89





Supplemental Condensed Consolidating Statement of Operations
For the Six Months Ended July 3, 2015
(in millions)
Freescale Ltd.
 
Guarantors
 
Freescale Inc.
 
Non-Guarantors
 
Eliminations
 
Consolidated
Net sales
$

 
$

 
$
2,995

 
$
3,130

 
$
(3,758
)
 
$
2,367

Cost of sales

 

 
2,052

 
2,944

 
(3,758
)
 
1,238

Gross margin

 

 
943

 
186

 

 
1,129

Research and development

 

 
293

 
145

 

 
438

Selling, general and administrative
4

 

 
322

 
107

 
(189
)
 
244

Amortization expense for acquired intangible assets

 

 
10

 

 

 
10

Reorganization of business and other

 

 
31

 
1

 

 
32

Operating (loss) earnings
(4
)
 

 
287

 
(67
)
 
189

 
405

Loss on extinguishment or modification of long-term debt

 

 
(30
)
 

 

 
(30
)
Other income (expense), net
267

 
267

 
40

 
200

 
(923
)
 
(149
)
Earnings before income taxes
263

 
267

 
297

 
133

 
(734
)
 
226

Income tax expense

 

 
25

 
9

 

 
34

Net earnings
$
263

 
$
267

 
$
272

 
$