Implementing a Relative TSR Plan: It's New To Me - An Issuer's Story October 24, 2013 Christopher Jensen Vice President, Global Compensation, Benefits and HR Operations, Freescale Semiconductor Claudia Yanez Senior Manager, Executive Compensation, SunPower Corp. (formerly with Freescale) Alexa Kierzkowski Consultant, Frederic W. Cook & Co.
Influences on Implementing a Relative TSR Program Dodd Frank / Say on Pay Proxy Advisors - ISS, Glass Lewis Shareholders Challenges with Long-Term Goal Setting Internal Motivations In 2013, Radford reported 831 Relative TSR plans (a 655% increase since 2007) Freescale s primary drivers were: Desire to implement a performance-based award Influence from shareholders On-going challenges with long-term goal setting
Relative TSR Design - Introduction The basic operation is as follows:
Relative TSR Design Freescale as an Example Number of shares is earned for TSR performance versus a peer group or index. Typical performance period is three years. Awards are valued using a Monte Carlo model (similar to using Black Scholes for options). With Freescale s starting price ($13.91) and 122% Monte Carlo value, each share has expense of $16.97. Expense is fixed at grant date (under Topic 718). Leverage from payout percentage and ending share price. Funding slope can be customized Three-Year % Target Value Earned ($000) Total Relative TSR Award if Ending Share Price is: P&L Cost vs Peer Group Earned $6.96 $13.91 $20.87 ($000) Max 75th Percentile 150% $615 $1,230 $1,845 $1,000 62.5th Percentile 125% $513 $1,025 $1,538 $1,000 Target 50th Percentile 100% $410 $820 $1,230 $1,000 37.5th Percentile 63% $256 $513 $769 $1,000 Thresh. 25th Percentile 25% $103 $205 $308 $1,000 <25th Percentile 0% $0 $0 $0 $1,000
Relative TSR Design Pros & Cons Pros: Strong shareholder optics Avoids long-term goal-setting issues No distortion from M&A Earned awards are justified by relative stock price performance More upside leverage than timevested RSUs IRC 162(m) deductible Cons: Stock price may not reflect internal performance (but relative TSR mitigates to some extent) Reliance on point-to-point TSR measurement P&L expense and disclosed value are not reversible (even if no award is earned) Reserves maximum number of stock plan shares during the performance period Accelerated vesting of PSUs upon CIC during performance period is inefficient under IRC 280G/4999 golden parachute rules compared to time-vested awards
Overview of Design Steps 1. Plan Participants 2. Comparator Group 3. Type of Plan 4. Funding Schedule 5. Detailed Design Provisions 6. Plan Definitions 7. Communication & Tracking
1. Plan Participants (Who Gets an Award?) Most companies limit to top officers or named executive officers Freescale includes all executives, which is about 150 participants Positive feedback that everyone is on the same plan
2. Comparator Group Big challenge for many companies Two main choices: Index Custom group of companies Freescale s choice Choose enough companies to prevent distortion from M&A, etc. Considerations in selecting peers: industry, revenue, market cap, geography, earnings, risk profile and other relevant characteristics Type of group: Freescale s choice Fixed - Compared to the components of the index at the beginning of the performance period Open - Compared to the components of the index at the end of the performance period
2. Comparator Group Freescale s Plan Company Revenue Net Income Cash & Cash Total Gross Enterprise Market Cap Equivalents Debt Value Advanced Micro Devices $4,925.0 $739.0 $1,003.0 $2,044.0 $2,593.6 $3,634.6 Altera $1,809.8 $566.6 $3,124.9 $500.0 $11,240.1 $8,615.2 Analog Devices $2,659.4 $644.6 $4,172.1 $757.9 $14,862.8 $11,448.5 Applied Materials $7,535.0 $392.0 $1,770.0 $1,946.0 $19,345.8 $19,521.8 Atmel $1,403.4 $37.6 $244.8 $0.0 $3,317.6 $3,072.7 Avago Technologies $2,377.0 $563.0 $1,151.0 $0.0 $9,108.6 $7,957.6 Broadcom $8,184.0 $822.0 $2,469.0 $1,694.0 $14,072.2 $13,297.2 Infineon Technologies $3,773.0 $267.0 $437.0 $166.0 $7,950.0 $7,921.0 Linear Technology $1,285.0 $408.3 $1,454.5 $0.0 $9,232.2 $7,777.7 LSI $2,452.3 $139.5 $658.5 $0.0 $4,077.7 $3,419.2 Marvell Technology Group $3,106.6 $265.3 $1,732.6 $0.0 $5,895.4 $4,162.7 Maxim Integrated Products $2,438.2 $446.5 $1,573.1 $807.9 $7,905.5 $7,140.3 Microchip Technology $1,581.6 $127.4 $1,578.6 $983.4 $7,789.4 $7,194.2 Micron Technology $8,047.0 $1,124.0 $2,228.0 $3,651.0 $13,614.4 $15,037.4 NVIDIA $4,310.0 $580.0 $3,713.4 $0.0 $8,212.2 $4,498.8 NXP Semiconductors $4,358.0 $412.0 $617.0 $3,185.0 $9,590.0 $7,022.0 ON Semiconducor $2,811.5 $96.2 $614.3 $949.6 $3,624.1 $3,959.4 Sandisk $5,187.7 $469.2 $3,310.2 $1,720.6 $14,777.3 $13,187.8 ST Microelectronics $8,302.0 $1,905.0 $1,583.0 $651.0 $7,390.0 $6,458.0 Texas Instruments $12,589.0 $1,856.0 $3,862.0 $5,683.0 $43,179.4 $45,000.4 Xilinx $2,168.7 $487.5 $1,714.7 $922.7 $12,008.4 $11,216.3 Mix of Exec Compensation peers and international companies Analysis of how well peers / index correlate to the company s stock (should be >.50)
3. Type of Plan Component Rank Plan (most popular) Freescale s choice Payout percentage is based upon the Company s TSR ranked against the TSRs of the peer companies Example: 150% is earned if the Company s TSR is ranked at the 75th Percentile or higher against the peer group Outperformance Plan Payout percentage is based upon the level of outperformance / underperformance of the Company s TSR as compared to a benchmark TSR Example: 150% is earned if the Company s TSR exceeds the performance of the chosen index by at least 20% points
4. Funding Schedule Freescale s Plan Freescale s Performance Schedule Three-Year Relative TSR vs Peer Group % Target Award Earned Max 75th Percentile 150% Monte Carlo Value Target 50th Percentile 100% 122% Thresh. 25th Percentile 25% <25th Percentile 0% Goal of the board was simplicity with schedule (and overall plan) Model many scenarios when considering funding schedule
Three-Year % Target Award Earned Relative TSR FSL's Alternative vs Peer Group Plan Considered Max 75th Percentile 150% 200% Target 50th Percentile 100% 100% Thresh. 25th Percentile 50% 50% <25th Percentile 0% 0% 1% increase in Perf. = 3% increase in Award 1% increase in Perf. = 2% increase in Award
4. Funding Schedule Considerations Payout schedule has a strong impact on the fair value of the award (under Topic 718), as determined by Monte Carlo model Fair value is often higher than stock price Design nuances can reduce the expense Lower the maximum payout percentage Increasing the maximum payment from 150% to 200%, would have increased Freescale s simulated fair value by 32% Increase the minimum payout percentage (but, less sensitive than max.) Adjust the target percentile (e.g., from median to 60th P) Exclude dividend equivalents, if applicable
4. Funding Schedule Considerations Design nuances can reduce the expense Cap total payout potential (e.g., 5x target) Implementation of Cap would have resulted in 12% reduction of Freescale s simulated fair value Absolute TSR threshold - limit payout to target for negative TSR Implementation of negative TSR cap would have resulted in 9% reduction of Freescale s simulated fair value Reduce the time between performance period start and grant date Significant challenge for Freescale, as annual grants have historically been effective in April, yet performance period begins in January. This resulted in an actual performance period that ultimately impacted the fair value of the award by 23%
5. Detailed Design Provisions Performance Period > 90% of companies use three years Qualifies as long-term with ISS Some companies measure performance over multiple periods (e.g., 1, 2, and 3 years) May help with transition to three-year period Freescale uses three years (1/1/13 12/31/15) Some challenges transitioning from 25% time-based vesting to 100% three year cliff
5. Detailed Design Provisions Averaging Period How to define beginning and ending share prices? A big concern about TSR plans that payout is influenced by market timing Averaging periods help minimize the impact of market timing and stock price volatility Most plans use an averaging period covering 1-month (20-trading days or 30-calendar days) Freescale uses a 1-month period, defined as the beginning and ending calendar months of the performance period
5. Detailed Design Provisions Dividends & Termination Dividends - Should employees receive the right to dividends issued over the performance period? Fairly common among dividend paying companies Important: should be based on the number of earned awards Termination provisions - How does the award pay out if the employee terminates? If employee terminates voluntarily or is terminated for cause, the entire award should be forfeited Death? Disability? Retirement? CIC? Is the award pro-rated for service? Basis for earnout (target vs. actual performance)
5. Detailed Design Provisions Freescale Termination Provisions Voluntary termination, involuntary not for cause termination or for cause termination entire award is forfeited Death or Disability prior to the first anniversary, award is forfeited. After the first anniversary, award is pro-rated based on time between grant and termination, at 100% target performance CIC performance period ends on date of CIC (or date determined by the Compensation Committee) and the award is calculated based on actual performance
6. Plan Definitions The devil is in the details define key terms up front Freescale Examples Relative Total Shareholder Return or Relative TSR means the Company s TSR compared to the Peer Companies TSR on a relative basis. The Company and the Peer Companies from highest to lowest according to their respective TSRs will determine Relative TSR. After this ranking, the percentile performance of the Company relative to the Peer Companies will be determined using the Percentrank formula in Microsoft Excel. Total Shareholder Return or TSR means for the Company and each of the Peer Companies, the company s Total Shareholder Return, which will be calculated by dividing (i) the Closing Average Share Value by (ii) the Opening Average Share Value, and then subtracting one (1). Accumulated Shares means, for a given day, and for the Company or a given Peer Company, the sum of (i) one share of common stock of the applicable Company, plus (ii) a cumulative number of shares of common stock purchased with dividends declared on the common stock, assuming same day reinvestment of the dividends into shares of common stock at the closing price on the exdividend date, for ex-dividend dates during the Opening Average Period or for the period between December 31, 2012 and the last day of the Closing Averaging Period, as the case may be.
7. Communication & Tracking Stakeholder management Securing senior leader and Board/Committee buy-in Financial reporting and expense modeling Introduction of the new plan How it fits into the pay philosophy, etc. Ongoing tracking Important for financial reporting (calculation of diluted EPS) Communication with participants Radford s PeerTracker enables customized, daily tracking of awards
Freescale: 2013 2012 2013 Executive 50% 50% 33% 33% 33% Stock Options RSUs Stock Options RSUs prsus
1/1/13 12/31/15 FSL - $10.11 FSL - $25.00 Relative Returns Co. A - $2.40 Co. B - $33.26 Co. C - $41.88 Co. D - $5.86.. Co. L - $8.32 Co. M - $25.02.. Co. Q - $30.58 Co. R - $35.41 Co. A - $8.61 Co. B - $42.06 Co. C - $49.65 Co. D - $19.56.. Co. L - $21.01 Co. M - $47.54.. Co. Q - $43.65 Co. R - $47.58 Co. A: 259% Co. D: 234% Co. L: 153% FSL: 147%... Co. M: 90% Co. Q: 43% Co. R: 34% Co. B: 26% Co. C: 19% 58 th Percentile Performance Data and summary for illustrative purposes only
2013 $20,000 $20,000 $20,000 Stock Options RSUs prsus Grant Information TSR Performance Summary Final Award Value for prsus $20,000 FSL Closing Price on 4/2/13 $13.91 Target Number of prsus 1,438 FSL TSR 147% FSL Relative TSR 58th Percentile Share Delivery Factor 1.16X Final Number of prsus 1,668 Fair Value of prsus $41,700 Target Value / Closing Price on 4/2/13 Target Units * 1.16 * $25.00 Data and summary for illustrative purposes only
2013 Aon Corporation
2013 Aon Corporation
Contacts Christopher Jensen Vice President, Global Compensation, Benefits and HR Operations Freescale Semiconductor R11011@freescale.com Claudia Yanez Senior Manager, Executive Compensation SunPower Corp. (formerly with Freescale) cyanez0909@gmail.com Alexa Kierzkowski Consultant Frederic W. Cook & Co. AHKierzkowski@fwcook.com