恩智浦 (NXPI) 2012 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the third quarter 2012 NXP Semiconductors N.V. earnings conference call.

My name is Sonja and I will be your coordinator for today.

I would now like to turn the presentation over to your host for today's call, Mr. Jeff Palmer, Vice President of Investor Relations.

Please proceed, sir.

Thank you, Sonja, and good morning, everyone.

Welcome to the NXP Semiconductors third quarter 2012 earnings call.

With me on the call today is Rick Clemmer, NXP's President and CEO, and Peter Kelly, our CFO.

If you've not obtained a copy of our third quarter 2012 earnings press release, it can be found on our Company website under the Investor Relations section at nxp.com.

Additionally, we have posted a supplemental earnings summary presentation and an Excel document of our historical financials to assist in your modeling efforts.

This call is being recorded and will be available for replay from our corporate website.

Please be reminded that this call will include forward-looking statements that involve risks and uncertainties that could cause NXP's results to differ materially from management's current expectations.

The risks and uncertainties include, but are not limited to, statements regarding the macroeconomic impact on the specific end markets in which we operate, the sale of new and existing products, and our expectations for financial results for the fourth quarter of 2012.

Please be reminded that NXP undertakes no obligation to revise or update publicly any forward-looking statements.

For a full disclosure on forward-looking statements, please refer to our press release.

Additionally, during our call today we will make reference to certain non-GAAP financial measures which exclude the impact of purchase price accounting, restructuring, impairment, and other charges that are driven primarily by discrete events that management does not consider to be directly related to NXP's underlying core operating performance.

Pursuant to Regulation G, NXP has provided reconciliations of the non-GAAP financial measures to the most directly comparable GAAP measures in our third quarter 2012 earnings press release, which will be furnished to the SEC on Form 6-K and is available on NXP's website in the Investor Relations section at nxp.com.

Now I'd like to turn the call over to Rick.

Thanks, Jeff, and welcome, everyone, to our earnings call today.

As is our practice, I will address revenue trends in our various markets and channels, with Peter providing more color on profitability and other financial metrics.

Looking at the third quarter, we are very pleased with our performance.

Overall, the quarter developed basically in line with our expectations, even with the deteriorating economic environment, with the product revenue coming in at $1.11 billion.

This represented a sequential increase of 9%, in line with the midpoint of our tightened guidance range.

Total NXP revenue was $1.17 billion, a 7% sequential increase, in line with our guidance.

Furthermore, our third quarter results mark an inflection point in year-on-year growth comparisons, as product revenue increased nearly 15% versus the year-ago period, confirming the growth we have been highlighting.

Our performance during the quarter was a clear reflection of the Company's specific growth opportunities we have previously identified coming to fruition.

We are optimistic about the contributions of these specific opportunities, including ID, and our mobile design wins, which were responsible for the bulk of the sequential growth.

So, we see the uncertain macro environment as creating real headwinds for the more cyclical portions of our business.

Taken together, the overall growth of the Company may be impacted over the next couple of quarters, notwithstanding the contributions from key high-volume design wins.

Irrespective of the macro environment, our strategy continues to be focused on providing unique and differentiated product solutions to our customers, which, over the longer-term period, should enable NXP to out pace the cyclical growth of the overall semiconductor market.

Turning now to our segment performance, HPMS revenue was $901 million, a 12% sequential increase, and up 24% from the year-ago period.

Within our ID business, revenue was $275 million, up 18% sequential and up 72% from the third quarter of 2011, clearly better than our original expectations.

We continue to experience healthy order trends across most of the portfolio, with our core ID business growing 14% on a sequential basis, and representing about 75% of the total ID revenue.

Within the core ID, automatic fare collection, infrastructure, and tags and labels were all up in the quarter, while our bank card business experienced strong double-digit growth as the trend towards contact-less bank cards continued to accelerate.

Within our e-government product line, sales were off slightly on a sequential basis, consistent with our expectations after the strong trends during the first half of 2012.

During the third quarter, our next generation SmartMX 2 secure element platform was awarded the industry's first common criteria EAL6+ security certification by the German BSI.

This is clearly a significant event as the intellectual property and capabilities embedded in our SmartMX platforms are at the core of why NXP is the trusted global leader in identification and security technology.

To date, we have shipped over 1 billion SmartMX-based products into the marketplace, with 86 countries leveraging our products for e-passport solutions.

Turning to our emerging ID business, which includes mobile transactions and authentication, revenue was up 30% sequential and represented about 25% of the overall ID group revenue.

Nearly all of the emerging ID growth during the quarter was due to NFC-based mobile transactions.

Our design win momentum in mobile transactions continues to build, as we continue to be tracking over 200 design opportunities, with roughly half of those programs in mass production.

Furthermore, during the quarter we achieved the 100 million unit shipment milestone for our industry-leading PN544 NFC controller.

Demand for this product is being driven not only by handset OEMs, but also by consumer product manufacturers who are adopting NFC to enable short-range secure media sharing solutions in a wide variety of products.

The ID Group continues to excel with a solid outlook, even in this tough environment.

Now moving to our Portable and Computing end market, revenue was $220 million, up 24% sequentially, and 31% up from a year-ago period, as our success in the mobility space comes to fruition.

During the second quarter, we experienced strong sequential due to the ramp in previously discussed design wins, with demand for both high-speed interface solutions, and logic devices, as new mobility programs we have previously highlighted began to achieve their full ramp.

The sale of MCU products were down slightly in the quarter, more a reflection of the weaker demand within the broad industrial market.

Turning to the Infrastructure and Industrial, revenue was $165 million, up about 13% sequentially, essentially in line with our expectations, while revenue was up about 1% versus the year-ago period.

During the third quarter, growth was driven primarily by an improvement in demand for our high-performance RF products sold to base station OEMs.

Both lighting drivers and silicon tuners were up modestly, with our number one leadership TV tuner business up 9%, while GreenChip power solutions were flat sequentially, a reflection of the challenging notebook PC market environment.

Within our Automotive business, revenue was $239 million, down 2%, slightly below our original expectations, but in line with the historical seasonality for our automotive business.

Versus the third quarter of 2011, revenue was up 7%, primarily due to share gains in OEM-based auto entertainment and keyless entry portion of the portfolio.

From a product perspective, we experienced good sequential demand for our entertainment products, with in-vehicle networking and sensors flattish, with keyless door entry products declined modestly in the quarter after stronger trends in the first half-year.

We experienced very good trends with US and major Asian suppliers, while we achieved new -- where we achieved new record sales levels.

This was offset by a weaker trend with European OEMs, particularly in the mid-to-low end of the market, as well as some impact from exchange rates.

Finally, turning to the Standard Products business, revenue was $213 million, down 3% sequentially.

That was slightly below our original expectations.

Versus the year-ago period, our Standard Products business was down 13%, as the broad-based market has continued to weaken throughout the year, even with some partial offset in new thrust product areas.

Turning now to our distribution channel performance, total NXP sales into and out of distribution were aligned, and were both up 4% from the prior quarter.

Total distribution sales represented slightly less than 15% of total product sales, fairly consistent with long-term trends.

We continue to tightly manage distribution inventory within our target range, with total months of supply on hand remaining at 2.4 months, basically flat with the prior quarter.

Absolute dollars of inventory in the channel were up about 6% on a sequential basis, as we positioned specific products to service certain high-volume programs by distribution.

Due to the uncertain macro environment and our distribution partners being the primary channel to service the smaller, broader-based customers, we anticipate a more conservative bookings environment over the next quarter or so.

From a geographic perspective, demand profile was similar to last quarter.

All regions, with the exception of EMEA, were up, with a particular double-digit strength coming from both the China and South Koreans markets, a direct reflection of our success with the key mobile handset customers, as well as contact-less banking customers in China.

In the EMEA region, which accounts for about a quarter of our product revenue, we experienced weakness across the entire product portfolio, with the worst performance being in the more broad-based exposed business like Standard Products, and, to a lesser degree, Identification and Automotive.

In summary, the third quarter was a very good quarter for NXP.

Many of the programs in the mobile space we have worked diligently on are paying dividends and we believe there is more to come when additional programs ramp up in mid-2013.

Our focus will be to manage these areas of the business within our direct control, especially in light of the clearly weakened macro environment.

Specifically, we are focused on managing our costs, driving cash generation, and managing our debt.

We believe if we are successful our actions will result in a very good bottom-line earnings growth.

Now I'd like to turn the call over to Peter to discuss the financial details of the quarter.

Thank you, Rick, and good morning to everyone on today's call.

As Rick has already covered the drivers of the revenue during the quarter, I'll move directly to the highlights of the P&L.

Overall, it was a strong quarter.

Revenue improved 7% sequentially, non-GAAP net income improved over 25% sequentially, and net debt was reduced by just over $100 million.

Subsequent to quarter end, we retired $202 million of our 2013 debt, and late yesterday announced that we have improved our liquidity by expanding our revolving credit facility to $805 million.

We also announced that we intend to tender for up to $500 million of our 2018 9-3/4% senior secured debt.

For the third quarter, revenue was $1.17 billion, in line with the midpoint of our guidance.

We generated $542 million in non-GAAP gross profit, an increase of just over 7% sequentially and non-GAAP gross margin was 46.3%, slightly better than the previous quarter.

Now, let me turn to the operating segments.

Within the HPMS segment, revenue was $901 million, up over 12% on the previous quarter, and operating margin was 23% of revenue, which at $208 million, was up over 18% sequentially.

Non-GAAP gross profit was $465 million, an increase of nearly 9% sequentially.

This represented 51.6% of revenue, a 170 basis point decline on the previous quarter, driven by the relative mix of our volume drivers, as I discussed at our recent Analyst Day.

Within our Standard Products segment, revenue was $213 million, down nearly 3% sequentially, and operating margin was 15.5%, which, at $33 million, represents a 3% sequential improvement.

Non-GAAP gross profit was $73 million, a 9% improvement over the prior period.

Total operating expense was $311 million, up $8 million on a sequential basis, and in line with the midpoint of our guidance range.

From a total operating profit perspective, non-GAAP operating profit was $232 million, an increase of nearly 14% on a sequential basis, and represents a 19.8% operating margin.

Interest expense was $65 million, a little better than expected as we paid down $50 million of our 2013 super-priority notes early in the quarter.

And our non-controlling interest was $16 million, a little higher than expected, as a result of improved performance in our SSMC joint venture.

Taken together, total NXP non-GAAP earnings per share were $0.56, in line with the midpoint of our guidance.

I would note that included in our non-GAAP net income was $12 million of stock-based compensation, or about $0.05 per share.

Now I would like to turn to the changes in our cash and debt.

Cash at the end of the third quarter was $702 million, a sequential decline of $135 million as a result of debt reduction actions.

Our total gross debt improved by $237 million in the quarter, down from the level of $3.58 billion.

So, overall, our total net debt at the end of Q3 was $2.88 billion, an improvement of $102 million versus the previous quarter.

On September 7th we called $202 million of our 2013 super-priority notes, with an effective call date of October 8th.

We have since retired these notes.

We exited the quarter with a trailing 12-month adjusted EBITDA of $989 million, and our ratio of net debt to trailing 12-month adjusted EBITDA at the end of Q3 was 2.9.

Turning to working capital metrics, days of inventory were 97 days, a decline of 9 days.

Days receivable were 37 days, a decline of 1 day sequentially, while days payable was 79 days, a decline of 7 days.

Taken together, our cash conversion cycle improved to 54 days from 57 days in the prior quarter.

As I mentioned earlier, we increased the size of our revolver to EUR620 million, or approximately $805 million, and, along with our excellent working capital management, and the cash in our balance sheet, I believe we now have very strong liquidity.

Cash flow from operations was $192 million, a result of strong revenue growth, improved operating profitability, and positive working capital metrics.

Net CapEx investment during the quarter was $92 million, resulting in positive free cash flow of $100 million.

As you, no doubt, have now realized, our Treasurer and I have been busy during this past quarter and will continue to work on our liquidity and debt, and I continue to expect to reduce our net debt as our performance drops cash through to the bottom line.

And largely as a result of our most recent actions, we now expect interest charges in 2013 to be in a range of $200 million to $220 million.

Now, I would like to provide our outlook for Q4.

As Rick mentioned, our view of the macro -- our view of the macro environment has clearly deteriorated since our last update.

While we are very encouraged by the progress in ramping up several key design wins in multiple areas of our business, the weak demand environment is having an impact on the more cyclically oriented portions of our business.

As we've said in past updates, our philosophy with guidance is to provide our stakeholders with the latest and most accurate view we have on potential business outcomes during the quarter.

In this environment, it is an even more challenging undertaking.

With these views as a backdrop, for the fourth quarter, we currently anticipate product revenue will be in a range of down 3% to down 9% sequentially.

At the midpoint, we expect product revenue to be down about 6% sequentially, reflecting the following trends in the business.

On a percentage point basis, Automotive is expected to continue to be challenged by the macro environment and should be down about mid single digits sequentially.

Identification continues to demonstrate strength and is expected to be flat sequentially.

Portable and Computing is expected to be down about 10% sequentially, primarily due to macro weakness impacting the broad-based general purpose logic and microcontroller business, offset by continued performance of key mobile design wins.

Infrastructure and Industrial is expected to show seasonal declines and be down in the upper-single-digit range.

Standard Products will continue to be impacted by the macroeconomic environment, and is expected to be down in the upper single digit range.

We anticipate revenue from the combination of our manufacturing segments and the corporate and other segment to be approximately $45 million.

Taken together, total NXP revenue should be in the range of $1.059 billion to $1.126 billion, or about $1.093 billion at the midpoint.

Additional inputs to help you tune your models are as follows.

Net debt will be about flat, quarter on quarter, as we use the expected cash generated from operations to fund the redemption costs associated with the tender offer of the 2018 senior secured notes.

We anticipate non-GAAP gross profit to be in the range of approximately $491 million to $524 million.

We anticipate operating expense in Q4 to be in a range of approximately $305 million to $309 million, and, taken together, this should translate into a non-GAAP operating profit in the range of about $187 million to $216 million.

Net interest expense should be $53 million or $56 million, depending on the results of our tender.

Cash tax expense should be approximately $11 million, and non-controlling interests should be about $17 million.

Stock-based compensation is expected to be about $16 million, or about $0.06 a share, which is included in our non-GAAP results.

Average diluted share count should be about 253.3 million shares, and, taken together, our guidance implies non-GAAP earnings per share in a range of $0.41 to $0.53 per share, or approximately $0.47 per share at the midpoint of our guidance range.

Now, we'd like to turn to your questions.

Jeff?

Sonja, would you please poll for questions, please?

Thank you.

(Operator Instructions).

Your first question comes from the line of John Pitzer, Credit Suisse.

Please go ahead.

Yes, good morning, guys, and congratulations on the good numbers.

I guess my first question for Rick, relative to the ID business and the Portable and Computing business, can you just give us a little bit of breakdown of the buckets within that and how you see growth going into the calendar fourth quarter?

And I guess, specifically, I'd be interested on the P&C side, how much do you -- what percent is core today versus kind of some of these new products that are ramping?

Well, John, I think when you look at it, as we talk about the growth that we have in the business in Q3, of the 9%, there's maybe a percent or so that is kind of reflected in our I&I business, associated to base stations.

But really the bulk of our growth comes from the combination of the growth of our ID business in mobile transactions, which is roughly half of that 8%, and then the significant design wins that we've talked about on the interface and switch side, associated with the Portable and Computing, which is roughly the other half associated with it.

As we look at those, that ramp was a very significant ramp in Q3 and, obviously, was a significant contributor to the growth that we had with high performance mixed signal being up 24% on a year-over-year basis.

If we look at moving into Q4, we would expect that ramp has basically taken place.

So, it would be -- those specific programs would be relatively flat in Q4, and with our typical seasonal pattern, combined with the really anemic economic environment, more specifically in China for us, we see an outlook that will be down in the rest of our business, driving the total reduction that Peter talked about of 3% to 9% for Q4 on a sequential basis, which, by the way, will still be up over 25% from a year-ago basis.

And then, guys, as my follow up, maybe for Peter, Peter, I know Standard Products is a relatively small part of the business, but the model didn't work as I would have expected in Q3.

On the plus side, you guys did a much better job on gross margins.

Kind of curious if that was mix or if these are kind of structural cost changes that can go forward?

And I was a little bit surprised that the gross margin benefits didn't necessarily translate down to the operating line.

So, if you can just help me understand, the Standard Products business a little bit better, that'd be helpful.

Yes, no, there was -- I -- there is a, I guess, a potential structural issue, if you like, John, in the sense that Standard Products, at the moment, from a utilization perspective is running -- is running quite weak.

So, their fixed costs tend to be -- tend to be quite high.

So, I think the biggest impact in Standard Products right now is -- comes in two areas.

One, the macroeconomic environment is pretty weak, so pricing is tough, not -- certainly not any worse than the -- than we've seen in the previous quarter, but the loadings on the fabs is quite anemic at the moment.

So, until we see a turnaround, I don't think you're going to see a big fall-through in the Standard Products area.

So, John, maybe I could just add a little more color to that.

There's some of the really low-end products that are very marginal, even gross margin, that we actually didn't participate in.

We walked away from those orders.

We did not want to continue to participate in that.

So, some of the aggressive price competition, primarily led by some of the Chinese manufacturers, we actually did not participate in, as we really tried to focus on our thrust areas in even Standard Products, really, again, more focused on our smart phone customers where they really need more increased ESD protection, et cetera.

So, that was one of the factors.

We are doing a little bit on the R&D side, not very significant dollar-wise, investing in linear, really in the Standard Products space because of the inherent technology we have and the significant market opportunity that we see associated with that.

So, we're investing in trying to be sure that we can get that business back within the target models that we believe that we can operate in and it's just a contribution of how we get there.

But clearly, we walked away from a reasonable amount of the true low-end basis, based on the aggressive price competition that we continue to see in that space.

Perfect, guys.

That's very helpful.

Thank you.

Thanks, John.

Operator, next --

Thank you.

The next question comes from the line of James Covello, Goldman Sachs.

Please go ahead.

Great, guys.

Good morning.

Thank you so much for taking the question.

First question, you guys have had some terrific wins in high-profile in the interface segment of your business.

I guess a couple of questions around that.

First, how comfortable do you feel about the IP around your interface products, such that no one could come in and sort of replicate that?

I know there's been some noise around that in the market.

Secondly, how do you kind of handicap the pluses and minuses of retaining some of the high-profile design wins you've had in future generations of products that you've already won, versus, on the up side, the opportunity to pick up new products, maybe with some of those same customers, with this technology?

Thanks.

So, thanks, Jim.

I think that this really is a clear demonstration of our technical capability.

I think from our overall position we believe that our IP is clearly adequately protected as we have a very strong IP portfolio and we clearly will utilize that to be sure that we product our product position, associated with it.

So, we're not significantly concerned about someone coming in.

We think that our IP position, which we will be prepared to use to our fullest extent to protect our product capability, will put us in a great position associated with it.

Clearly, for us, the opportunity is roll this out to more and more successful smart phone and tablet customers, and ability to drive the fundamental capability.

So, proving that technology and really being a significant player in the smart phone and tablet space really puts us in a different position to be able to drive some of the volume and the increase in demand.

Okay.

And then, if I could ask a followup on the -- on the debt, I understand the comment about the forecast for 2013 interest expense being between $200 million and $220 million.

It looks like that would assume no additional repayment of debt over the course of 2013, given, essentially, that's close to the run rate that we're on, exiting the fourth quarter.

And so, are there things that you could do that aren't in those assumptions, or is the idea that you've kind of done what you can for the time being on the paydown of incremental debt?

Thank you so much.

No, I mean, there's -- while we have the level of debt that we have, there's always more we can do.

That just happens to be my best view right now.

But clearly, our priority is continuing to pay down the debt and we're going to generate a reasonable amount of cash as we move forward over the next few quarters, and we'll continue to use that to focus on how we continue to reduce our debt.

I appreciate it.

Thank you so much.

Good luck.

Thanks a lot, Jim.

The next question comes from the line of Vivek Arya, Bank of America Merrill Lynch.

Please go ahead.

Thanks for taking my question.

It's interesting that I think because of the mix in HPMS this quarter there's been some pressure on gross margins, but operating margins have actually grown quite nicely.

Is that the new trend, Rick, where gross margins, perhaps, stay below the targets, but operating margins are able to hit the targets?

Or was that just a function of mix during this particular quarter?

No.

That's what we talked about at the Analyst Day, and what we expect to continue to see.

We have not backed off of our gross margin target model, but as we talked about with some of the new higher-volume design wins that are not necessarily at the highest levels of gross margin but deliver a very good bottom line, we expect to see some of that transition taking place, but very confident that we can make the improvements in operating income.

Peter?

Yes.

No, I think what I said at the Analyst Day is I believe we can see a very clear track to get into our operating margin model relatively quickly.

Gross margin, given the profile and the mix of our business at the moment, is a little bit more challenging.

But, yes, absolutely, you should continue to see good performance from an operating margin perspective, and we do need to continue to work on gross margin.

And it was not a one-quarter phenomenon.

Yes.

Right.

And I think, Rick, you also mentioned in your prepared comments that the conditions could stay tough for a couple of quarters.

Was that a general macro comment, or was there anything specific to NXPI that you see?

And, I guess, within that, if you could remind us of what Q1 seasonality looks like?

Thank you.

So, I think it's really more of a reflection of the anemic economic environment we see.

Clearly, China is very critical to us, as a company, with as much of our business that flows into Greater China as it does.

And so, what we've seen is we've definitely seen a slowdown take place in the market in China, more in line with the rest of the world.

There's some discussion that after the elections and then a few months after that, when they begin to provide the economic stimulus, we could see an improvement of the environment in China, but it's not something that we have a divine perspective of.

I mean, we've really been talking about this for three or four quarters, an anemic economic environment.

And we saw about a three or four month period of time where, clearly, China improved.

It's not the case today and with that fundamental anemic economic environment, we're not optimistic about a real growth in the fundamental business with the exception of the ramp-up of these more specific design wins that we've talked about.

But if you look at seasonally, our seasonal pattern, which is hard to really talk about seasonal basis in the semiconductor business, with the inherent fundamental cyclicality, but we're typically down in Q4, as we've talked about, and down in Q1 on a sequential basis, then with a really strong rebound in Q2 and Q3 before we, then, roll off slightly in Q4 and down in Q1.

So, that's kind of our typical seasonal pattern, but I'm not sure that there's anything that's very typical seasonal in the semiconductor business.

All right.

And one last one, if I may.

If macro conditions remain sluggish as they are, should we expect to see bigger draw-downs from the distribution channels, or, essentially, more destocking in the channels.

I think you mentioned sell-in and sell-out were roughly the same, around 4% sequential growth in Q3.

To be fair, that's always a challenge with our distribution partners.

They would like to be sure that they reduce their inventory to the absolute lowest level possible.

We'd like to be sure that they maintain adequate inventory to be able to supply our customer base.

If you look at us, track us over the last year or so, we have been in the range of 2.4 to 2.7 months of inventory for the last five or six quarters.

So, we're clearly at the bottom end of the range that we've been in over this period of time, and would not want to see those inventory levels go down significantly from where they are today.

But -- and we think anything from 2 to 3 months of inventory is actually a very reasonable basis associated with it.

So, we feel comfortable that we're at the right level of inventory.

That may not be the case in every different product area.

You have to look at the absolute details associated with it, but we would not expect to -- we would not want to see a significant reduction associated with the disty inventories, but that's always a challenge in working with our partners associated with their turns and earns programs.

Great.

Thank you.

Thanks a lot.

The next question --

Sonja?

The next question comes from the line of Ross Seymore, Deutsche Bank.

Please go ahead.

Hi, guys, and congrats about weathering these macro storms here.

Just a question first, I think for Peter, on the gross margin side of things.

Given your revenue guidance and what it sounds like being some conservatism on the inventory side of things, I'm a little surprised that the gross margin is holding in as well as it is in the fourth quarter.

Can you walk us through the puts and takes of your guidance?

The biggest impact we have on our gross margin at the moment, Ross, is really mix.

We go from -- as we went from Q2 to Q3, the fall-through was a little bit more -- a little bit higher than we would like, but actually where we expected it to be.

So, we were probably about 12 million short, and that was -- as I said, that was driven primarily by mix.

As we go into Q4, you see the fall-through is only -- even as we reduce, the fall-through is about 45%, which maybe is a little bit better than you expected, but it really is -- it really is driven by mix.

So, there's not been big, from a cost perspective, or a cost reduction perspective that is driving that number.

So, if I could just add one thing, Ross, if you really think about the gross margin, one of the key factors associated with that is factory utilization.

And in our IC wafer fabs, we continue to be at a pretty good factory utilization, 92%, 91%-plus.

Yes.

And so that continued strength of the factory utilization on the IC space continues to give us some ground basis, give us some foundation associated with our gross margin in HPMS.

So, I think that's really the key factor associated with it for us.

And let me --

To be honest, Ross, we would -- our challenge at the moment is to continue to improve our gross margin, but it's going to be a while before you see it at the level that we'd like to see it at.

And to be specific, I was talking about HPMS.

Clearly, in Standard Products, we're operating at lower factory utilization and it's clearly one of the pressures that we do have on gross margin, Ross.

If the HPMS side specifically, the utilization sounds like it's staying pretty flat in the fourth quarter, what are your expectations on inventory?

And, I guess, I'm a little surprised that you keep the utilization that high, given your macro commentary?

Well, I think you have to think about our manufacturing strategy, Ross.

We don't actually build everything internally from an HPMS perspective.

So, for example, quite a lot of our ID revenue, now, is built in external factories, and quite a portion of our P&C revenue in built in external factories.

And they're both areas that are doing relatively well.

I guess one final quick one, then.

On your new product areas, I know new product ramps don't typically have seasonal, and seasonality, these days, is a difficult topic to begin with, but how should we think about those sorts of -- those markets acting seasonally, considering that many of them are very consumer-oriented.

Yes.

I think that they'll follow the normal smart phone and tablet seasonal patterns, Ross.

You should think about it that way.

We've clearly ramped very aggressive in Q3, so we're kind of at the runway on the first two design wins at the -- in Q3, and so, as we said, we'd expect that to be relatively flat for Q4, but then follow kind of the seasonal patterns.

And then with really the next major design win ramping kind of middle of 2013, although smaller design wins that we'll actually have beginning to ramp between now and then, but not really as significant in moving the needle on the overall growth.

Great, thank you.

(Inaudible).

Thanks, Ross.

The next question comes from the line of C.J. Muse, Barclays.

Please go ahead.

Yes, good morning.

Thank you for taking my question.

I guess first question on gross margin, I guess if you look at the wins that you have in ID and Computing, and you look at your hybrid outsource strategy, how should we think about the uplift there, as those wins come to fruition and you see greater magnitude there in the model in calendar '13?

Is that something that we should see starting kind of first half, or is that more a second half story?

I'm not sure, C.J., I understood correctly.

I guess the -- on some of these high-volume design wins, clearly they won't be of the same profitability levels as kind of the fundamental rest of our business, but will drive more incremental growth.

So, we haven't talked about the specifics associated with those, but clearly not at the same levels.

But a big chunk of that has clearly ramped in the Q3 results associated with it, so as far as any balancing associated with that, we've seen that in the Q3 results.

So, it won't be a big factor swinging one way or the other as we go forward on a sequential basis from that Q3 base.

Yes, and I think what I said at the Analyst Day is we see a -- we see a path to exiting 2013 at an operating margin level of 25%.

One of the challenges for us will be to continue to improve our gross margin, gross margin percent, but the next -- the next milestone for us to achieve a gross margin with a 5 in front of it, and that's something we're working very diligently towards, but I think it'll be a while before you see it.

For the total bottom line.

For the total bottom line, yes.

That's helpful.

And I guess as a follow up, can you walk through some of the trends that you're seeing, particularly on the Industrial and Auto side, and what you can share in terms of your thoughts of if and when we'll see a recovery there?

Well, Industrial -- I think you should talk about them separately, frankly.

I think the Industrial side, we're seeing just the overall impact of the absolute poor or anemic economic environment across the board.

And you tell me when the economy's going to improve, and I'll tell you that's when the Industrial is going to improve.

I am hopeful that as China gets their government change and they begin to implement some of the programs, that early next year we could see an improvement associated with the marketplace in China, but that's a hope, as I said.

In Automotive, clearly, Automotive there's some pressure, but we just talked about we had record shipments in Q3 in both North America and China.

So, I think that really talks about our portfolio and where we are, and it's really going to be dependent on the number of cars manufactured, with clearly the projections on the number of units manufactured next year kind of slipping down a little bit, kind of flat to low single digit with kind of the expectations, which I think were a little -- a few points higher than that maybe three or four months ago.

So, I clearly think that we see a reduced outlook, but not a precipitous decline associated with the Automotive market.

Great.

Thank you so much.

Thanks, C.J.

Thank you.

The next question comes from the line of Chris Caso, Susquehanna Financial Group.

Please go ahead.

Hi, thank you.

I'm just wondering if you could address some of the earlier comments on gross margins, and just to be clear, the margin targets that you set out for the end of 2013, the 50% operating margin -- I'm sorry, 50% gross margin, 25% operating margin, are those still achievable in light of the current macro conditions?

Or do we think we need to wait a little bit before we achieve these?

Well, I mean, just to be clear, we said 25% operating margin exiting the full year, if the macroeconomic environment doesn't deteriorate, right?

I didn't actually say when we'd get to the 50% on the gross margin, so, I'd like to continue to maintain that wiggle room.

The reality is, if the macroeconomic environment continues to decline the way we've seen it in the last couple of months, yes, I think it would be a challenge.

But --

But if it doesn't worsen from here --

We'll be okay.

We still feel very confident that we can outgrow the semiconductor market for 2013, and so the real question is, is how bad does the overall economic environment get?

Yes.

If it doesn't deteriorate significantly from here, then probably we're in that range.

But if the economic environment were to continue to deteriorate and some of the world's economies moved into a true recession, then clearly that would have an impact associated with it.

Yes.

But I don't think we've seen a precipitous-enough decline in the economic environment that we would see any major change.

Yes, and clearly we've demonstrated now that we can outgrow the general market, and there's no reason that we see that that won't continue.

All right.

That's fair enough.

My crystal ball on that isn't any better than yours.

As a follow up, if maybe you could address the PC market, and that's one of the areas where we've seen some others see some larger-than-normal declines here in the fourth quarter.

Can you talk about -- and, I guess, as I look at your Portable and Computing business, it's still down, year-over-year, despite the handset design wins.

Could you address that and sort of where we are with that, what's your exposure, and what your outlook is for that part of the market?

Actually, we should clarify.

If you look at our P&C business, we're up 31% from a year ago in Q3.

And if we're flat, it'll still be a strong increase year-over-year in Q4.

So, I think we are experiencing the growth from those design wins that allows us to have that kind of fundamental growth on a year-over-year basis.

It's significant associated with it.

If you look at absolute PC, because PC -- when we talk about Portable and Computing, we're actually talking more on smart phones and tablets, as opposed to specifically PC side.

But we do have products that go into PCs, some of our interface products, some of our Standard Products, some of our logic products, that do go into PCs, that really probably the most significant area with a concentration into the network PC business is our GreenChip basis on the power supplies associated with that.

As we've talked about, that business was flat for us in Q3, so we're not expecting to see a huge decline, but, again, it's more focused on the notebook side and what we've really found is that some of the inventory gyrations associated with that space has more of an impact than just the fundamental PC demand, to be honest.

But it's not a significant factor in our overall business, other than kind of the Standard Products, and logic and discretes and some of the interface parts that we ship into the PC market itself.

All right, great.

Thank you.

Thank you.

Thank you.

The next question comes from the line of Joe Moore, Morgan Stanley.

Please go ahead.

Yes, thank you.

You mentioned in the Industrial business that the high performance RF sold to base stations was strong.

Can we just get a little more color on that?

How much of that is sort of your product cycle of design wins versus strength in the market?

It's really only associated with our design wins.

If you look at -- as we move forward in 3G and LTE, we have a significant share of the design wins as kind of most of the key customers have decided that our technology is kind of the technology of choice associated with it.

So, as the industry base station deployment moves more towards LTE and 3G, clearly we will have a much larger share than we did in the 2G and 2.5G markets, where we had a relatively low market share.

But those design wins have been years into fruition as we've worked on them, and now we see that taking place, specifically in the Q3 results.

But what we've found in the base station market is, it is probably one of the most volatile on a quarter-by-quarter basis of any segment of our business.

So, having those design wins is really the first step associated with it, and then how we manage the supply chain associated with the volatility in orders or lack thereof of base station deployment throughout the infrastructure is, frankly, probably one of the more significant challenges.

But we've made excellent progress in the high performance RF and think that we're the true leader in technology on the 3G and LTE base stations.

Great.

Thank you very much.

Thanks.

The next question comes from the line of Vijay Rakesh, Sterne, Agee.

Please go ahead.

Yes, hi, guys.

I think you managed your costs pretty well.

The hybrid model has been your gross margin source, but can you talk about what are the initiatives you have in moving the operating margin goalpost from 18% to 25%?

I'm sorry.

The line wasn't very good there.

Could you just repeat your question?

I said you manage your costs pretty nicely and the hybrid is helping your gross margins, but can you talk about what initiatives you have in moving the operating margins from 18% to 25%?

There's a number of things.

There's a number of things we can do, but one of the things that really helps us is as we grow with these specific design wins, how we -- and in how we grow with our ID business, in particular.

They are businesses where we've -- we get relatively weaker gross margin than our normal entitlement, but the volume covers our fixed costs in a much better way, so the fall-through we get is pretty substantial, actually.

Yes, I think it's probably worth pointing out that with the very anemic economic environment that we see, we're being very selective with some of our investments.

Clearly, we're -- we continue to step up our investments in our ID business and to focus on the smart phones and tablet space.

But in a lot of the other areas, we're basically pushing out some of the increased investment until we see a more robust economic environment where we feel like we have the capability to make those investments.

So, I think that's really a factor for us, is being very focused and very selective on our R&D investments and, clearly, we want to be clear that on the SG&A side we move towards best in class from an overall semiconductor performance viewpoint.

Got it.

And one last question here, when you look at your interest payments, it's already running in that $200 million to $220 million level for next year.

I think there was a previous question for that.

And now you have good cash flow here, too.

Any reason why you're not starting to look at some of these payments, paydowns again, later next year, about middle next year?

You guys are tough.

So only a quarter ago, I was saying $240 million to $260 million.

So, I'm going to be pretty pleased with $200 million to $220 million.

But, yes.

No, as we generate the cash, I will absolutely look at what we do with that and we're extremely committed to paying down our debt.

So --

Got it.

And we actually have some debt that comes due in 2013 that will pay down from just our operating cash flow.

Yes.

Got it.

And what's the CapEx for next year?

Did you give that out yet?

What we typically talk about is 5% of revenue through the cycle.

Got it.

Thanks.

Thanks, Vijay.

The next question comes from the line of Gareth Jenkins, UBS.

Please go ahead.

Yes.

Thanks for taking my question.

I just wanted a question on the MC market as to the trends that you're seeing there, particularly in relation to the 32-bit versus 8-bit, but I think you cited at your analyst day that 8-bit that was expected to be down around 14%.

I just wondered if you've seen any further deterioration in that, and any further acceleration in the 32-bit, or recovery, I should say?

And then secondly, I just wondered if you could give a sense of book-to-bill by some of your major areas as we head into the quarter, what the booking's looking like and how that's moving?

Thank you.

So, first off, on the microcontroller side, we talked about 32-bit being weak in the -- 32-bit for serving -- 32-bit ARM-based, serving the Industrial market, actually being weak in Q3, still.

So, I think that's probably -- it is weak, and until the general economic environment improves, we would not expect to see a robust recovery associated with the 32-bit ARM-based microcontroller business.

And I'm specific about that, because a significant portion of our ID business, obviously, is microcontroller, secure microcontrollers, as well.

So, I'm just trying to be specific about the 32-bit ARM-based microcontrollers for the Industrial space.

And I'm sorry, I forgot what the second part of your question was.

Book-to-bill.

Oh, book-to-bill.

Gareth, we don't provide a book-to-bill number on our call, primarily because our business has very different patterns across different end markets, and really if we give you a number it's really not very insightful, and that may actually cause you to draw the wrong conclusion.

So, we -- it's not a metric that we provide on our earnings call.

The one thing that we should say is, is orders have been weak for Q3.

I think we've said that, and they continue to be weak.

We feel comfortable with the guidance that we've said for the Q4 timeframe, but, clearly, orders are weak and we have to be sure that we continue to perform to be able to execute at the revenue guidance that we've laid out for Q4.

Thanks.

And just as a follow up, I mean, you've talked at length about inventories, and your own inventories, and the disties' inventories, but have you have any sense of the OEM inventory levels?

I mean, it feels like there's still a fair bit of inventory sitting at the OEMs in both Autos and Industrial, but have you got any sense of that?

Well, Autos, I think it comes down to many factors, as there's inventory levels throughout the value chain.

I understand that there are some cases where there's an inventory of high-end cars in certain regions.

So, clearly, that will be a factor and have to be worked down.

I think that as we look at flat to a 1 or 2 percentage point increase in overall Automotive shipments in 2013, that comprehends the expectation associated with normalizing the inventory in the Automotive space.

On the Industrial space, everybody has a theory about where inventories are.

I don't really believe that with the industry -- that all of our end customers, the way they are today, that there's a huge amount of inventory, because they -- a lot of our customers are on a pull basis, and I just don't believe that they have a significant ramp-up of inventory in place.

I see a lot of the press, but we certainly have no specifics that would confirm that.

Thank you.

Great.

Thanks, Gareth.

The next question comes from the line of Harlan Sur, JPMorgan.

Please go ahead.

Hi.

Thanks for taking my question, and good job on the Q3 results.

On the ramp -- it's good to see the ramp of your first high-speed interface products with your smart phone customer, and it sounds like, Rick, you're still on track to ramping your third interface product kind of middle of next year.

I guess my first question is, is NXP sole-sourced on all three of these products?

Well, so, Harlan, first off, we should be specific.

The first two design wins, one of those is a very sophisticated interface part, and the other one is a simple switch that is in it.

So, I just want to be clear associated with it.

If you look at the design win that we talked about that will ramp in mid-2013, it's actually a microcontroller associated with it, with unique applications associated with it.

But we think that we're in a very solid position.

Our customers have various sources of supply.

We think that we're in a very good position associated with these, and will continue to move forward in supporting all of our customers with the deployment of this technology.

Great.

And then, as it relates to your -- your RF -- your (inaudible) power amplifiers grew quite nicely in the third quarter.

I'm just wondering what's embedded in your guidance for those particular products in your outlook for the fourth quarter?

Well, we don't expect to see -- with the current expectations from customers, we wouldn't see that growth -- we'd see -- as we talked about earlier, that particular segment is very choppy associated with it, and we don't break down the specific guidance on our high performance RF, but the -- we're -- I guess real question is, when will the ramp-up of base stations take place on 3G and LTE?

I continue to believe that the fundamental requirements of data processing are going to drive a further increase in demand in base stations, and as that takes place, we feel very comfortable with the design wins we have, we'll be in a leadership position of ramp-up of revenue.

But it's going to continue to be choppy, and we're certainly not planning on any growth, and maybe a slight decline in Q4 associated with base stations.

Yes.

Just to add to Rick's comments there, when we talked about our guidance from Q2 to Q3, we mentioned that the increase in base stations was partly because we think some of our customers had gotten pretty lean in terms of their inventory, so they needed to restock a little.

So, you do see those swings that Rick talked about, yes, Q4 will definitely not be as strong as Q3 for base stations.

Great.

Okay, thank you very much.

But going into 2013, we're very optimistic as 3G and LTE base stations ramp that we'll be in a great position, Harlan.

Yes.

Great.

Thanks very much.

Thank you.

Thanks, Harlan.

Sonja, we'll take one more call, please.

Thank you.

The next question comes from the line of Philip Scholte, Rabobank.

Please go ahead.

Yes, good afternoon.

Given your comments on your macroeconomic view, are there any additional measures you are taking to protect margin, in terms of cost savings, closing down specific parts of fabs, anything in that respect?

We announced a couple of quarters ago that we were going to take our three fabs in Nijimegen in the Netherlands and move that over an extended period of time into one 8-inch facility to continue to drive further cost reduction associated with that.

So, we continue to work on that, and work towards that.

We'll always be working on our factory loadings and ensuring that we drive our cost reductions associated with it, but that's kind of the fundamental requirement in the semiconductor industry, and we'll continue to work on programs, as I said.

We're very focused on being sure that we move to top-tier SG&A performance and, clearly, that's an area that we'll continue to work, as well.

Right.

And, maybe as follow up, do you provide a geographical breakdown of the Automotive part?

We do not.

The real problem with that is, we ship to our customers, we're not sure where they actually deploy that.

Right.

Because they actually move product around.

So, anything that we would tell you on a regional basis, we think, would be misleading.

But it is important to realize that we had record shipments into North America and China in the Q3 timeframe in our Automotive business.

Right.

Right.

Okay, thank you very much.

Thank you.

Thank you very much, Philip.

Thank you.

I would now like to hand the call over to Mr. Clemmer, for closing remarks.

Thank you, operator.

So, we thank you for your continued interest in NXP.

In summary, we believe that our Q3 results demonstrated measurable success in executing on our long-term strategy.

Specifically, achieving product revenue growth of 9% in this overall economic environment, clearly better growth than our peers, really confirms the strategy that we've put in place and have been discussing with you.

We delivered improved operational performance, resulting in a 25% sequential improvement in net income.

And then the resulting $100 million of free cash flow generation clearly continues to drive our focus on deleveraging our balance sheet and continuing to reduce our debt with the repayment of $200 million of high-coupon super-priority notes.

With the fundamental anemic economic environment continuing to challenge sustained revenue growth, we think that our progress in new areas of engagement position NXP in a positive fashion that will support better-than-industry performance.

Thank you so much.

Thank you, everyone, and we'll speak to you in the future.

Thank you, operator.

Thank you for your participation in today's conference.

This concludes the presentation.

You may now disconnect.

Good day.