恩智浦 (NXPI) 2013 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Second Quarter 2013 NXP Semiconductors Earnings Conference Call.

My name is Sonia, and I will be your coordinator 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, go ahead, sir.

Thank you, Sonia.

Good morning, everyone.

Welcome to the NXP Semiconductors second quarter 2013 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 second quarter 2013 earnings press release, it can be found at our Company Website under the Investor Relations section at NXP.com.

Additionally, we have posted on our Investor Relations Website a supplemental earnings summary presentation and a document of our historical financials to assist in your modeling efforts.

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

This call will include forward-looking statements that involve risks and uncertainties that could cause NXP's results to differ materially from the 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 third quarter of 2013.

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

For a 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, stock-based compensation, 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 second quarter 2013 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.

Before we begin the call, I'd like to highlight our attendance at the following upcoming investor conferences during the third quarter.

We'll be at the Jefferies 2013 Corporate Assets Summit on August 28 in Chicago.

We'll be attending the Deutsche Bank 2013 TMT Conference on September 10 in Las Vegas.

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

Welcome, everyone, to our NXP earnings call today.

We are very pleased with our performance in Q2, which came in at the higher end of our guidance both on revenue and on earnings.

More importantly, we are also encouraged that the broad-base momentum we experienced in Q2 should continue into Q3.

Our results and our guidance are clear proof points of the diversity of our product portfolio and that the design win momentum we have discussed in the past is coming to fruition.

We believe our results are a reflection of the success NXP has achieved in delivering value-added products to our customers across multiple end markets.

I'd now like to move on to the results for Q2.

We delivered product revenue of $1.16 billion, a 10% sequential increase and a 12% increase from the comparable year-ago period.

This was in the upper range of our guidance.

Total NXP revenue in Q2 was $1.19 billion, just over a 9% sequential increase and nearly a 9% increase from the comparable year-ago period.

On a segment basis, total HPMS revenue was $878 million, up 13% sequentially and up 18% versus the year-ago period.

That was $15 million better than our expectations.

Our HPMS segment delivered excellent results, as we experienced robust, double-digit, sequential growth across all of our focused end markets.

I would also like to highlight that our Identification and Automotive HPMS businesses achieved record revenue levels during Q2, and both our now each solidly operating at revenue run rates of over $1 billion per year.

I'd like to thank both teams for their intense customer focus (inaudible) to achieve the targeted goals.

Turning now to the performance by HPMS end markets, revenue in our Identification business was $339 million, up 13% sequentially and up 45% versus the year-ago period.

Our core ID business was up 28% sequentially, representing over 80% of the overall ID revenue.

This is a new record revenue and was above our expectations due to the combination of better-than-anticipated demand for contactless banking products, as well as very good demand for automatic fare collection and infrastructure products, which are areas we don't talk about much.

Design momentum for our core ID products continues to be very strong across all verticals.

Our emerging ID business declined in the quarter, with lower mobile transaction revenue.

We expect that our mobile transaction business will be roughly flat year on year due to the effect of already well documented product transition at one of our major customers.

And the adoption rate of the new design wins continues to be truly outstanding.

We continue to see encouraging volumes of new design wins at all of our customers with over 300 SKUs currently having been awarded.

With a clear shift to our next-generation NFC and secure element technology, it will bring about an even better consumer experience and more enhanced security.

Interest in our new authentication products continues to gather steam, but we will likely take a little bit longer than originally thought to merge the material revenue business for us.

Turning to our Automotive business, revenue was $253 million, up 10% sequentially and up 4% versus the year-ago period.

That was above guidance.

The business delivered strong sequential growth due to a combination of better-than-seasonal demand, the launch of the new customer entertainment programs, and the continued ramp of major keyless door entry programs.

Now, turning to our Industrial & Infrastructure business, revenue was $180 million, up 18% sequentially and up 15% versus the year-ago period.

Performance in the period was very good across the entire portfolio, with all product lines contributing to the growth.

High-performance RF for base station applications and small-signal RF devices experienced growth above 10% sequentially and more than 15% year on year, primarily due to the ramp of new programs, which we have highlighted in the past.

We believe the long-anticipated 4G build-out in China is still ahead of us, beginning in the second half of the year, which should help support even further growth.

Our power and lighting business was up over 20% in the quarter, though from a small base, but, still, very good growth.

We continue to maintain our leadership position in silicon tuners with the business up in the high, single-digit range during the quarter.

Within our Portable & Computing business, revenue was $106 million, up 14% sequentially but down 1% versus the same period a year ago.

Our high-speed interface and microcontroller business were both up in the low teens percentage range on a sequential basis.

Growth during the quarter was primarily a result of a rebound in our broad-based, non-mobile business.

Consistent with our expectations, the initial shipments of the new sensor hub microcontroller design win began as expected.

We also experienced a modest rebound in demand for existing mobile interface designs at a tier-one mobile OEM.

Our traction with new and existing design wins in the smartphone space is doing very well.

Turning to the Standard Products segment, revenue was $281 million, up 1% sequentially and down 3% versus the same period a year ago.

Our performance was slightly below our expectations as a result of weaker-than-projected sales for certain logic products within the mobile end market.

The revenue performance of our discrete business, which has had some issues over the last couple quarters, has incrementally improved and was up during Q2.

As we've said in the past, the top line performance of our Standard Products segment is a good first-order approximation of the direct influence of the macroeconomic and external cyclical patterns on our business.

Moving on to the distribution channel performance, absolute inventory dollars in distribution was flat versus the prior quarter.

On a dollar basis, sales into distribution were essentially in line with sales out.

The total months of supply within our distribution channel declined to 2.2 months, below our longer-term metric of around 2.4 to 2.6 months.

We see this as low for the level of future business we anticipate and are working with our distribution partners to improve inventory levels.

In summary, our performance in Q2 was very good.

Our HPMS segment is firing on all cylinders.

Our model of strong franchises across multiple end markets is enabling us to perform exceptionally well, even if certain high-profile markets like PCs and high-end smartphones experience moderating growth.

The product line teams have worked diligently on the overall 26% operating margin performance target and to execute on the operating expense controls programs while, yet, still investing in R&D for future drivers of growth.

The HPMS segment is now performing solidly above 27%, within the operating margin model we had targeted.

The Standard Products segment is slowly beginning to recover, and we have confidence of its return to expected performance levels.

We are very confident in achieving our overall Company margin targets, as Peter will highlight in a moment.

Taken together, our performance translates into top line growth, better than industry peers, very good and improving operating profitability, and stellar bottom line earnings growth.

We believe our model will continue to deliver superior earnings growth.

Now I'd like to turn the call over to Peter to review the financials in more detail.

Good morning to everyone on today's call.

Overall, we delivered a very good quarter, the main highlights being stronger-than-expected top line revenue growth, stronger-than-expected non-GAAP earnings, the continued pay-down of our debt, as well as completing a debt transaction which converted about $750 million of floating-rate, secured debt to fixed-rated, unsecured debt with a very attractive interest rate.

Moving on to the specifics of the quarter, top line revenue was $1.188 billion, up 9.5% versus the first quarter and above the midpoint of our guidance.

We generated $540 million in non-GAAP gross profit, or 45.5% non-GAAP gross margin.

This was about $46 million better sequentially when removing the one-time legal benefit we recorded in our first quarter results.

Total operating expense was $285 million, or 24% of revenue, an improvement of over 200 basis points versus the first quarter.

During the quarter, we made excellent progress on the expense control programs we've previously highlighted, and we are clearly demonstrating the operating leverage in our model.

We continue to invest in R&D, and, although we stepped up our R&D investment, we were not able to raise it quite as much as originally planned.

All in all, this resulted in non-GAAP operating profit of $256 million, or 21.5%, about 50 basis points better than our guidance and 200 basis points versus the first quarter; again, normalizing for the one-time benefit realized in Q1.

Let me now turn to the segment performance.

Within our HPMS segment, revenue was $878 million, up 13% versus the prior period and approximately $15 million better than expected.

HPMS non-GAAP gross profit was $472 million, or 53.8%.

And non-GAAP operating profit was $238 million, or 27.1%.

In our Standard Products segment, which, to remind you, is now the combination of our general purpose logic and discrete business, revenue was $281 million, up 1% sequentially and approximately $9 million below our target.

The Standard Products segment non-GAAP gross profit was $67 million, or 23.8%, and non-GAAP operating profit was $26 million, or 9.3%.

The internal manufacturing issues we discussed on the last earnings call are largely resolved and should have minimal impact in the second half of the year.

Interest expense was $47 million, slightly better than expected.

Non-controlling interest was $18 million, about $1 million above the guidance.

And cash taxes were $9 million, or about $3 million better than expected.

Taken together, our non-GAAP earnings per share was $0.71, about $0.05 better than the midpoint of our guidance, as a result of better revenue and lower operating expenses.

As a reminder, our non-GAAP earnings does not include stock-based compensation, which was $20 million for the quarter.

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

Our total debt at the end of the second quarter was $3.38 billion, down $59 million from the first quarter.

During the quarter, we completed a $750-million, unsecured note transaction, and we used the net proceeds and cash on hand to repay both our $616-million 2016 secured, floating-rate, term loan and our $243-million 2013 floating-rate notes.

The new bond carries a fixed interest rate of 3.75% and is due in 2018.

We continue to see interest expense in the $185 million range this year and are committed to our ongoing deleveraging programs.

Cash at the end of the quarter was $569 million, down $26 million sequentially.

And we exited the quarter with net debt of $2.8 billion and a trailing, 12-month, adjusted EBITDA of approximately $1.2 billion, resulting in a net debt to trailing, 12-month, adjusted EBITDA leverage ratio of 2.3 times.

I'm very pleased to say that we believe we should achieve our 2-time leverage ratio exiting the year, which will be a significant milestone for the Company.

You'll note we bought back 1.7 million shares at a cost of approximately $48 million, or just over $28 per share, during the quarter.

Additionally, yesterday, a new $10-million share repurchase program was authorized.

Consistent with our prior program, our repurchase efforts are primarily aimed at offsetting the dilution related to employee option exercises.

Turning to working capital metrics, days of inventory were 104, a decrease of 7 days.

And, excluding the pre-builds for the restructuring of our fabs in Europe, it was 93 days.

Receivables days were 38, down 1 day, while payable days were 73, down 5 days, resulting in a cash conversion cycle of 69 days, a 3-day improvement from the prior quarter.

Cash flow from operations was $160 million, and net CapEx was $46 million, resulting in $114 million in free cash flow, or approximately 10% free cash flow margin.

Now I'd like to provide our outlook for the third quarter.

Influencing our outlook again this quarter is strong demand due to Company-specific design wins in multiple areas of our HPMS business.

We currently anticipate product revenue to be in the range of up 4% to up 8% sequentially.

At the midpoint of this range of 6% sequentially, we anticipate the following trends, all on a percentage-point basis.

Within our HPMS segment, we expect Identification revenues to be down low/mid single digits.

Within our Auto business, we expect revenue to be flat; so, relatively strong, given normal seasonality.

Within Infrastructure & Industrial, we expect revenue to be up in the low teens range.

And we anticipate our Portable & Computing business to be up in the upper 20% range, as new mobile programs begin to ramp in earnest.

Within our Standard Products segment, we anticipate mid single-digit sequential growth.

We anticipate the combination of Manufacturing and Corporate & Other to be about $34 million.

Taken together, total NXP revenue should be in a range of approximately $1.23 billion to $1.29 billion, or $1.26 billion at the midpoint, up about 6% sequentially.

We expect non-GAAP gross profit to be about 46% at the midpoint, and we expect operating expenses to be about flat at 24% of revenue, both in dollar terms, as we continue to invest in R&D and sales programs to support our ongoing and planned growth.

Taken together, our guidance should translate into a non-GAAP operating profit in the range of $268 million to $288 million.

Interest expense on our debt should be approximately $44 million, cash taxes roughly $7 million, and non-controlling interest expense should be about $16 million.

Stock-based compensation should be about $20 million, which is excluded from our guidance.

Diluted share count should be about 258 million shares, depending on share price fluctuations.

Taken together, this translates into non-GAAP earnings per share in a range of $0.78 to $0.86, or $0.82 per share at the midpoint of our guidance.

One further housekeeping item.

In July, the board of directors of SSMC, our joint venture wafer fab with TSMC, approved and distributed a special dividend in the amount of approximately $120 million, as is normal at this time of year.

As a reminder, the joint venture is owned 62.5% by NXP and 37.5% by TSMC with the financials consolidating into NXP.

The net result is our total cash balance has been reduced by approximately $46.5 million for this item in the third quarter.

Finally and before I move to my summary, I'd like to provide an update on our stated margin expansion programs.

At this point in time, we're on track with both our margin improvement programs and our OpEx improvement plan.

We are confident that, in Q4, we will achieve our goal of exiting 2013 at 26% non-GAAP operating margin.

In summary, a strong set of second quarter results, coupled with a strong outlook for the third quarter.

Our revenue growth is clearly in excess of the market and is broad based.

We continue to generate significant cash and pay down debt, and we'll reach our debt to EBITDA target ahead of our plan, by the end of 2013.

Our earnings continue to improve, and the leverage in our model is being demonstrated with a 6% planned growth in revenue for the third quarter, driving a 16% growth in net income.

With that, I would like to turn it back to the operator and ask for your questions.

Sonia, would you, please, poll for questions?

(Operator Instructions).

John Pitzer.

Congratulations.

Really good top line and bottom line performance.

I wanted to ask a couple questions around the margin profile for June-September and the full year reiteration.

Just relative to the June quarter, it looks like you were slightly light of your guidance; by our math, all due to Standard Products.

So, Peter, I'm kind of curious why you think Standard Products is now at a bottom and is going to improve from here.

And, specifically, relative to the forward September guide on gross margin, what's the expectation for Standard Product gross margin next quarter and, quite frankly, HPMS, given that a lot of the growth is coming from P&C, which tends to be lower gross margin but op margin neutral?

I guess a couple of things, John.

You're right.

In the quarter, we were a little bit lower than we expected at the gross margin level on the Standard Products segment, and it was -- I think, in Rick's notes, he mentioned that we were a little bit light on GPL revenue, which related to smartphone and tablets.

And that does tend to be a bit higher margin.

So that's really what hit us for Q2.

We really don't plan to guide our HPMS and Standard Products gross margin percent.

But I think, if you look back to kind of historic levels, there's no reason why a return to what we'd expect in Standard Products shouldn't drive probably 150 basis points improvement at the total NXP level on its own.

I can't remember.

You had a third question embedded in there somewhere.

It was the idea of P&C driving a lot of the growth sequentially in the September quarter.

It tends to be a lower-margin business.

Is that all offset by the strength in I&I?

It's a combination of things, John.

I think it's safe to say that we feel comfortable about the guidance for Q3 with a combination of P&C and I&I.

I think it's also important to point out that some of the operational issues we talked about over the last couple quarters in [GA] -- we have seen improvement.

The actual financial improvement result is delayed a quarter, as you know from our PII implication, so it doesn't actually show up in the bottom line results in the quarter as that performance improvement takes place.

Perfect, guys.

And this is my follow-up.

Peter, glad to hear you reiterate exiting the year at that 26% op margin target.

It does imply a relatively healthy jump Q3 to Q4.

So I'm just curious.

Are there any sort of incremental OpEx cuts we get Q3 to Q4 to help you achieve that target?

Or why so confident in that target exiting the year?

Well, I think there's kind of two sides of it, John.

On gross margin, we highlighted the three general areas we were working.

We're very, very confident in the way they are progressing, so I'm very, comfortable with that.

I do think Standard Products will recover.

And you'll note our gross margin guidance for the quarter is kind of 46% to 47% on the range.

So I think a small pickup in Standard Products would deliver on the gross margin programs.

And OpEx -- I'll be very honest.

A lot depends on the mix.

My assumption has been around 50% gross margin and 24% OpEx.

Really, dependent on the revenue mix, you could have a slightly weaker margin, maybe 49% or 49% and a bit.

But, if that happened, then OpEx would naturally be lower as well.

But it's hard to say at this point.

Q4 is still a long way away.

But I'm quietly confident that the 26% is there.

Perfect.

Thanks, guys.

Congratulations again.

Vivek Arya.

What do you see the strength in Infrastructure & Industrial -- ? Rick, I'm wondering.

How should we think about it beyond Q3?

On the one hand, there is expectations of all the China at the EBIT.

But, on the other hand, comps are getting tougher after a strong Q2 and your guidance for Q3.

So how is the level of visibility along some of these infrastructure bids?

And how much is the visibility into an inventory build versus actual consumption?

We've been rather cautious in setting expectations; specifically, in our high-performance RF area based on the ups and downs and the lack of predictability associated with those demands.

What we see is that, definitely, some of the customers are beginning to prepare with some initial orders to ensure that they can meet the requirements of the ramp-up.

But when that actually gets shipped is very inconsistent, to say the best, over a period of time.

So we still plan that business fairly conservatively and are not counting on huge upticks immediately based on that.

But, based on the demand that we see from our customers, we feel comfortable associated with the outlook that we're talking about.

And the other thing.

Just how should we think about seasonality, then, in Q4, because you also have other very strong growth in your P&C segment.

ID is also seeing very strong growth.

Last year, also, you had a couple of very good quarters and then somewhat more of a seasonal outlook in Q4.

So how should we think about seasonality this year as you look at all the demand drivers?

As you know, our view on seasonality -- there's no real magic here.

We look at our backward-looking revenue that we posted, and we take a median value over the past three years.

And, if you look at I&I in the last number of years, it's stronger in Q2 and in Q3, a little weaker in Q4 but not substantially.

So I don't think that there's anything magical we can give you -- insight in terms of seasonality on that.

Got it.

One last question just on Standard Product gross margin.

I think you mentioned that a couple of the issues had been resolved, and the main weakness right now was just on the GPL side, I assume tied to some of the smartphone ramps.

So, other than the mix issue, is there anything else that we should be worried about, whether it's a pricing issue or any other issue that would prevent improvement in Standard Product gross margins?

Thank you.

No.

I don't think so.

I think we're seeing a little bit of the pricing kind of like we did last year in Standard Products, where we saw the significant decline in Q1 and then a little more stabilization.

We were a little bit gun shy about whether we would see that this year, but I think we've seen some of that more stabilization in Q2 or, at least, starting by the middle of Q2, I would say.

So, no.

I think that we feel pretty comfortable relative to the guidance that we've given associated with Standard Products.

Vivek, one thing to remind you also.

Remember, in our business model, the effects of improved utilization are seen one quarter afterwards.

So, as you saw in our results, utilization did go up in Q2, which was primarily in the Standard Products area.

The effects of that will flow through the P&L we'll be seeing in Q3 and beyond.

So I think the issues that we had in our manufacturing facility are largely behind us.

The utilization is improving.

We feel very confident in Standard Products getting back to where it's operated in the past.

And, by the way, you know the performance associated is well above all the competitors in that space.

Even the performance that we demonstrated with weakness associated with it still puts it at one of the best-performing standard products business in the industry.

Great.

Thank you.

James Covello.

Congratulations on the good results.

I guess first question relative to the model that you've all laid out many times, the $5 billion in revenues, $4 in EPS.

First, assuming there's no change to that model --

Second, we're at that revenue run rate now in the September quarter -- a quarterly revenue run rate that would get us to the $5 billion, and we're at $0.82 in EPS.

Could you give us the bridge chart that would walk us from the $0.82 in EPS to the $1 in EPS going forward?

Thank you.

Well, I guess, first of all, I do believe we can get the $4 EPS.

And the bridge is pretty simple, Jim.

You just have to get to 26% EBIT.

Well, I mean, I guess -- How much of it -- ? Is it just all that?

It doesn't have anything to do with interest expense?

It's just all the EBIT?

You can work out the math.

It's pretty straightforward.

The key thing for this as a company is generate 26% EBIT.

We're already starting to throw off lots of cash.

We'll throw off even more cash.

Interest costs come down pretty dramatically.

And you get to $4 pretty fast.

So, if anything, I feel more confident now than I did last September.

That's great.

And then, from a follow-up perspective, and I had asked this question to you guys several times over the years, including at that analyst meeting where you originally laid out the model, given the choice between faster revenue growth and lower gross margins, you've said in the past you would take any business, even if it were lower gross margins, that was operating profit dollar accretive.

Does that continue to be the model?

And, therefore, should people maybe worry a little bit less about your gross margins and focus a little bit more on the operating profit?

Absolutely.

I mean, what we've talked about all along is that we're trying to drive bottom line EBIT results that deliver cash flow -- free cash flow for the business.

And we've said that we'll have ups and takes on product mix on gross margin.

And, really, the key focus should be driving the bottom line EBIT results, which is what we're focused on and what we're driving associated with it.

So, looking at the OpEx and the gross margin are indicators about how we're going to get to that, but the bottom line is we're very focused on driving the 26% EBIT and being able to continue to make progress associated with that.

And so we'll continue to generate the significant free cash flow that we'll generate going forward that will continue to pay down our debt and be very accretive on an earnings basis.

When you look at the backward earnings since our IPO, we've had about a 56% compounded growth in earnings.

And we look at the opportunity to continue to drive well above anybody else in the industry on forward earnings growth.

Yes.

I remember our conversation well, Jim.

And I think, if we have a choice between significant revenue growth in excess of what the market sees and 26% EBIT, I'd take that every time as opposed to 28%, 29%, 30% and very low revenue growth.

So we think high revenue growth business with 26% EBIT would just drive massive value for our shareholders.

That's terrific.

Thank you very much, and congratulations again.

Blayne Curtis.

This is [Mark Kelley] on for Blayne.

The first question I have is about your authentication business.

It sounds like maybe it's pushed out a little bit.

So my question is -- are you still expecting to get the same share, or has something else changed?

Any color there would be helpful.

Yes.

We're still very excited about our authentication business.

Any time you have a new business that's fundamentally a new core technology, it takes -- it will either be faster or slower than what you planned relative to the ramp-up associated with it.

While we're really encouraged on some of the activities that we have going on in cyber security, some of the opportunities to provide a more secure solution and access to the cloud that would not require -- or that would be much more powerful than the current password protection that we all use, and some of the opportunities for authentication on products, we still are just as encouraged about the opportunities there and, in fact, see it as maybe even larger than we did three or four quarters ago.

But the ramp-up specifically associated with some of those programs is not quite as rapid as we had originally envisioned.

But no real indication of anything.

And, in fact, we think the strength that we have, the unique security expertise that we bring, is still well positioned to be able to provide a secure access to the cloud.

Authenticating your access to the cloud will be a major factor in cyber security protection.

Rick, just to reiterate Mark's question, no share loss that we see.

This is really just a slower takeoff of a new business for us.

Exactly.

Mark, did you have a follow-up?

I do, I guess, in terms of inventory levels.

By geography, are there any areas that you think are more lean than others?

Any color you guys have would be helpful.

Thanks.

Are you talking about, specifically, as it relates to the distribution channel?

Yes.

I think that, clearly, in Asia, I think there is a little less inventory.

It's obviously different levels by each one of our distribution partners, and some less and some more.

But I think there's probably a lower level of inventory more on the Asian side than the rest of the world.

And that's clearly one of the areas that we're trying to work with our distribution partners on getting to the appropriate level of inventory to be able to support the increase in future demand that we see rolling up.

Okay.

Great.

Thanks a lot, guys.

And I should be very specific probably.

Our revenue guidance at the midpoint doesn't have a lot of increase in distribution inventory reflected in that, although it would have a little bit of an increase in the low level that we ran in the most recent quarter, the 2.2 months, in the high end of the range of revenue.

Chris Caso.

Maybe just to start, just an order of clarification.

As you look into the fourth quarter operating margin guidance, it does seem that, in getting to that number, it would suggest a good increase in gross margins.

Is the right interpretation of that -- as you said previously, there's a quarter lag between the increases in production and the impact on gross margins.

Is that the explanation for what we're likely to see in Q4?

No.

What we talked about previously, Chris, is those three big programs we're working on.

One's related to our wafer pricing -- I mean, not literally just pricing but some costs associated with wafers.

Another part is associated with basic blocking and tackling, including gold-to-copper conversions and the like.

And the third relates to our IP profile.

Clearly, there's a benefit from Q3 to Q4 -- sorry -- Q2 to Q3 on utilization, but I would not expect a significant benefit from Q3 to Q4 on utilization.

Okay.

So it's mainly on the cost side and on the addition of IP revenue to the portfolio that benefits the gross margin in Q4.

Yes, exactly what we've talked about previously.

And keeping our OpEx under control, to target.

Okay.

And, just as a follow-up then, you talked about that you didn't have a significant inventory restocking in distribution in your third quarter guidance.

But I guess, if the conditions continue, what sort of signals are you getting back from your distributors at this point?

And, I guess, at what point would the distributors be forced to put on a little additional inventory?

And, I guess, in conjunction with that, what sort of visibility do you have as the inventory levels at your customers?

I guess a couple things.

On distribution, I think one of the things with distribution -- when you're growing as rapidly as we are, it's sometimes not easy to keep the channel as stocked as the way you would like.

So we would see some movements from quarter to quarter.

I don't think we're seeing the -- maybe Rick would like to come on.

I don't think we're really seeing the channel or end customers having too much or too little inventory at this point in time.

It seems pretty balanced.

No.

I think that's a good point.

I mean, you got to remember that all of our automotive customers, basically, is vendor-managed inventory, which is onsite for them.

So, as far as they're concerned, that's at a very reasonable level.

As we look at supporting the smartphone and tablet customers, that's very hand-to-mouth associated with it.

I guess the one area that we've been ramping and was a significant ramp up of our revenue in Q2 was specifically associated with the contactless banking business for China, where, clearly, that's a ramp-up of the pipeline associated with it.

And, at some point in time, we'll see that come to more of a normalized run rate associated with it.

But that's the only area at all where I think there was really a huge supply chain -- not replenishment but establishment.

And that kind of gets lost a little bit in the rounding.

But it's a factor in the guidance that we set for our ID business, which is down slightly for Q3 on a sequential basis.

Okay.

That's helpful.

Thank you.

Steve Smigie.

Congratulations on the nice numbers.

Rick, I was wondering if you could talk a little bit about potential growth drivers as we look out to 2014 for the ID business.

And, specifically, I wanted to inquire about, say, the banking card business there and the transit business.

For the banking card business, does it take a ramp in, say, US chip-and-PIN banking cards to make that business grow, or are there other things that are more likely to be the driver in 2014?

And, for the transit, are there specific programs that you have to sort of be getting indications on now in order for that to get at sort of typical growth rates for next year?

I think our ID business, with this broad portfolio of applications -- everything, as you say, from the transit side to mobile wallets to the contactless banking to PIN/chip for US or North America with the implementation associated with it -- and, also, we continue to be very excited about the cyber security protection associated with it.

We feel very confident in the growth of our ID business, having double-digit growth.

Specifically, the China contactless banking has been a real opportunity for us, and it's driven a lot of our growth over the last couple of quarters.

It's been a significant contributor to that growth.

But we see that still growing.

We see that still being a significant position, where we've really been able to facilitate that transition in that market and play a key leadership role in driving that.

And what we are seeing is, now, more and more interest as we go to mobile payment for people to begin to look at adding MIFARE and fare collection onto mobile phones to be able to accomplish that.

So, again, that just provides additional opportunities associated with the ramp-up with our unique, proprietary leadership technology that we do license to other people as well.

So I think there's a multitude of platforms that will continue to give us the confidence in our growth in our ID business, and we look forward to continuing to see the double-digit growth not only next year but for the next few years.

Did you have a follow-up?

Yes, just to drill down on your answer there a little bit.

On the mobile wallet that you mentioned with the MIFARE, is that mostly going to come in the form of some sort of licensing, or you end up on a solution where you are included separately maybe from just a semiconductor solution?

And then, specifically on handsets, too, does it still seem likely to you that, even if maybe your radio business wasn't as strong for NFC, that the secure element portion of that still looks like on its own -- could ramp pretty nicely next year?

MIFARE could be in the form of licensing.

It could be in the form of shipments.

So it will be in the form of both.

I think the fact that there's excitement about the usage of smartphones is a key factor.

So we could deliver that in either way.

I think the key thing for us in the mobile wireless is we have seen the integrated radio be pushed out in time.

And, with our next generation of product that we're just beginning to ship, we see increased performance associated with that so that we see the potential for a discrete solution to potentially have longer life than we would have anticipated a year or so ago.

And, with that and with the increased technology that we have in this next generation of product, bringing a better consumer use and improved levels of security, we think, is really key associated with that.

So, even though the consolidation of the radio is ultimately going to take place in the connectivity chip, we see the opportunity for us to continue to play in the mobile wireless space in a significant fashion as we go forward for the next year or year and a half; certainly, the next six to eight quarters.

Steve, I'd just add to Rick's comment.

If you look for proved points, in Rick's prepared remarks, we talked about being awarded over 300 SKUs, which go across the handset and other consumer products.

So I think companies are looking at who has the best technology from a security perspective, which companies have the best radio performance, who has the best interoperability.

And I think they're coming back to NXP, and our design win momentum continues to reflect that.

Thank you.

And this is all about a security side, and it's about the ability to deliver that bulletproof security.

And that's where we think we do the best.

Ross Seymore.

Congratulations on the strong quarter and guide.

Just following on on that ID side of things, clearly, quite different performances between your core and emerging in the June quarter, as we kind of expected with what's going on in the handset side.

Any color you can provide on those sub-segments within your down slightly guide for the third quarter?

And, really, what I'm trying to get at is where the base on the emerging side -- where either the inventory correction and/or seasonality comes into play and normalizes.

Thank you.

I think, as we said, the guidance -- it's a reflection of two things.

Number one is I talked about the pipeline that we've been filling up significantly in the China contactless banking.

At some point in time, we'll see that ease off a little bit, Ross, to go to a steady run rate as we get that supply chain really filled.

To be fair, there are some of the individual government programs that have pushed out in time and is reflected, as governments look at where they're spending their dollars.

So we still see the same opportunity for electronic passports, electronic ID cards.

But it's maybe pushed out a little bit in time, and that's reflected in our view as well.

So I think it's a combination of all of those that says we're going to be slightly down in Q3 timeframe.

But, still, feel very comfortable with the double-digit growth for that business as we look forward, Ross.

Great.

Then, I guess, as my follow-up one for you, Peter, you guys have done a great job on the balance sheet management.

You're confident that you're going to exit this year at your 2-times-levered target.

Versus that $185 million that I think you guided to for the full year this year, any sort of, at least, directional help on what you would expect your priorities to be for 2014 on that same metric, please?

Thank you.

Well, I guess, a couple of things.

Obviously, guiding $44 million for next quarter, I would say four times that number would be lower than $185 million.

But the direction is definitely lower, Ross.

We're in the middle of looking at our 2014 forecast, so it's difficult to say at this point exactly how much lower.

We have one big chunk of debt we're really interested in, the 9.75%.

But the breakage costs on that are just so high it doesn't make sense right now.

But I'm sure we'll go after that early in 2014, and that will help us on interest cost as well.

Great.

Thank you.

Harlan Sur.

Solid job on the quarter, the execution.

As you mentioned, another leg to the margin improvement is to be able to monetize the broad IP portfolio.

I think your target is to generate about $10 million per quarter in recurring revenue, starting in Q4.

I know these negotiations can be tough.

So how confident is the team around being able to secure and close some of these licensing deals in or before the fourth quarter of this year and then to drive that sustainable run rate on a go-forward basis?

Harlan, as you and I both know, there's no guarantees associated with that because that's up to a negotiation process associated with it.

I think the fact is that we've been investing in this area and driving this for an extended period of time.

We have lawsuits in place -- taking place.

So we are very optimistic about the ability to drive the income from the intellectual property side.

But, to be fair, things can happen with court systems, et cetera.

But I think we have all of the action played out to be able to accomplish that, and we just have to be sure that we follow through and we're able to execute within the boundaries of the court systems and the negotiations with the third parties to be able to support that.

But we're very confident to negotiate with it.

Thanks for that, Rick.

And, then, on the automotive side, you mentioned the launch of a new entertainment-focused program with a new customer.

Is this focus around your car radio, software-defined radio, Telematics product offerings?

And how much proliferation are you getting with this new customer across their portfolio?

It's broad based.

I think, as we said before, we now are the technology provider of choice for 27 of the 28 mid- and high-end car radios associated with it.

So I would say that our technology has really become the technology solution of choice in those mid- and high-end car radios.

And this is really the ramp up of two or three of those design wins that we had won a couple of years ago that we're seeing the shipments associated with moving forward.

So we continue to make great progress in that area.

But the position we have there is extremely solid, and we'll continue to grow our revenue.

And it's one of the reasons that allowed us to become the number-one semiconductor supplier shipping into China in 2012 with the recent industry reports that came out.

Great.

Thanks, Rick.

Will Stein.

I'm hoping to dig into the prioritization on cash use once you hit 2 times net leverage.

We had, perhaps, some indication with the new buyback authorization.

It would seem that a buyback at around these levels would perhaps be more accretive than even taking out the 9.75%.

Can you give us an update in that area of the business, please?

Well, I think what we said is, once we get to 2 times trailing, 12-months EBITDA, we'll review our options and do whatever is best for our shareholders.

Clearly, we believe, at the current stock price, we're significantly undervalued.

So, Rick might shoot me for saying this, but I think, if we get to the end of the year and our stock price is still $33, my guess is it would make a lot more sense for shareholders to buy back stock than continue paying down debt.

But I think we need to get there first and then decide what we do.

I think it's very clear that we have our goal to be able to achieve the low 2 times annualized EBITDA from a debt position.

And then what we'd said is we're going to do whatever we believe is in the best interest of our shareholders in driving additional shareholder value.

Thanks for that.

And, then, one follow-up, if I can, again on the ID segment.

I'm going to go there as well.

I think there's been some pretty widely discussed growth opportunities in the US for chip-and-PIN relative to the EMV initiative.

Do you still see that?

Perhaps, what's your visibility into demand driven by that initiative?

We still have discussions and are supporting that process.

I know that the credit card companies had set specific metrics where they will raise the fees that they charge if there's not the PIN-and-chip implementation.

So I think the key factor that takes effect is, if you look at the implementation in Europe with the PIN-and-chip, the (inaudible) rates are an order of magnitude below what they are in the US, where there's just the magnetic strip associated with it.

So I think there's going to be -- continue to be an effort that, probably, the most near term will be associated with Canada but pretty rapidly followed by North America.

So we continue to see an opportunity.

That's out over the next few years, not the next few quarters, to be quite fair, associated with it.

But it's still a strong growth opportunity associated with our ID business.

Thank you.

Vijay Rakesh.

Good numbers here.

Just a question on the 4Q guidance.

You said operating margin expanding nicely, by 400 bips.

Do you expect to see that improvement come about 50/50 from gross margins and OpEx?

I didn't say.

And, to be honest, I didn't really -- I'm not into guiding the fourth quarter.

What I'm saying is that we expect we'll deliver 26% EBIT.

But I don't want to get into how much is revenue and how much is margin and how much is OpEx at this point in time.

We normally only give you a one-quarter view.

Got it.

On the license side, I know you're expecting a pickup there.

Is that something you'll break out going forward?

And how does the pipeline there look?

As you look at 2014, do you expect to see -- expect to add more guys on the licensing side?

We've not disclosed that.

And I guess we've not decided what we will do at this point.

What we've said is that it should be able to create, basically, 100 bips of our margin enhancement, and we feel pretty good about the ability to be able to accomplish that for Q4, as well as 2014.

Great.

Thanks.

Sonia, we'll take one last caller, please.

Mark Lipacis.

Most broad-based suppliers saw an increase in days at their distributors.

And I was wondering if you could help us reconcile why you saw yours -- it sounded like yours went down.

I think it's because our revenue has grown faster than our competition, basically.

Our dollars were flat quarter to quarter.

Our reduction from 2.4 to 2.2 months of inventory was basically as a result of the numerator increasing.

So they weren't able to put inventory in place at a sufficient run rate to be able to maintain the inventory levels that we think would be appropriate.

Fair enough.

And did you talk about lead times to your customers -- what they did during the quarter?

It's really mixed, to be fair, because lead time -- it's hard to have a blanket lead time associated with it, with lead times that vary across the board.

I would say that we did see some areas where lead times edged up a little bit but not anything that would be a significant, material change.

Thank you.

Well, I think that will be the end of the call today.

I'd like to pass it over to Rick in case there's any closing remarks you'd like to make, Rick.

Thanks a lot for your interest.

We're very pleased with the performance that we delivered in Q2, the ability to continue to drive double-digit growth in revenue and make good, solid bottom line profits.

And, with our HPMS business now performing within our operating income model that we've established, it gives us the confidence in the ability to point to actual results to demonstrate the value of the strategy that we've put in place.

As we look forward, we continue to be very optimistic about continuing to drive significant EPS growth and outgrowing the market from a top line revenue.

So thanks a lot for your interest, and we appreciate your support.

Thank you very much, everyone.

Thank you for your participation in today's conference.

This concludes the presentation.

You may now disconnect.

Good day.