NXP Semiconductors NV Management Discusses Q1 2013 Results - Earnings Call Transcript

Apr.23.13 | About: NXP Semiconductors (NXPI)

NXP Semiconductors NV (NASDAQ:NXPI)

Q1 2013 Earnings Call

April 23, 2013 8:00 am ET

Executives

Jeff Palmer - Vice President of Investor Relations

Richard L. Clemmer - Chief Executive Officer, President and Executive Director

Peter Kelly - Chief Financial Officer, Principal Accounting Officer and Executive Vice President

Analysts

John W. Pitzer - Crédit Suisse AG, Research Division

Blayne Curtis - Barclays Capital, Research Division

Jonathan Steven Smigie - Raymond James & Associates, Inc., Research Division

Christopher Caso - Susquehanna Financial Group, LLLP, Research Division

James Covello - Goldman Sachs Group Inc., Research Division

Ross Seymore - Deutsche Bank AG, Research Division

David Phipps

Vivek Arya - BofA Merrill Lynch, Research Division

William Stein - SunTrust Robinson Humphrey, Inc., Research Division

Vijay R. Rakesh - Sterne Agee & Leach Inc., Research Division

Operator

Good day, ladies and gentlemen, and welcome to the NXP Semiconductors First Quarter 2013 Earnings Conference Call. My name is Shequana, and I will be your coordinator for today. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. 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.

Jeff Palmer

Thank you, Shequana, and good morning, everyone. Welcome to the NXP Semiconductors First 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 first quarter 2013 earnings press release, it can be found in our company website under the Investor Relations section at nxp.com. Additionally, we have posted a supplemental earnings summary presentation and a document of our historical financials to assist in your modeling efforts. Both of these documents and including today's press release will reflect our recently announced product reclassification. 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 second quarter 2013. 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, 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 on the non-GAAP financial measures to the most directly comparable GAAP measures in our first 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 today, I'd like to highlight our attendance at the following upcoming conferences. We'll be attending the Jefferies 2013 Global TMT Conference on May 17 in New York City. We'll be attending the JPMorgan 41st Annual Global TMT Conference on May 1 in Boston. We'll be attending the Barclay's 2013 High Yield Bond and Syndicated Loan Conference on May 21 in Chicago. We'll also be attending Barclay's 2013 Global TMT Conference on May 22 in New York City and the BofA Merrill Lynch Global TMT Conference on June 4 in San Francisco.

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

Richard L. Clemmer

Thanks, Jeff, and welcome to our earnings call today. We are again quite pleased with the revenue performance we had in Q1, following our strong performance in 2002. Our product revenue was $1.06 billion, a 15% increase from a year ago, while being down 2% sequentially and at the top end of the guidance we issued.

Total NXP revenue during the quarter was $1.09 billion, a 3% sequential decline, an 11% increase from the comparable year ago period. Overall, our first quarter profit was better than we expected with a clear contribution coming from the release of a legal provision after a favorable decision and an outstanding legal dispute.

Looking at the market, overall, our macro view is similar to what we discussed with you in January. We are yet to see an economic rebound but only spots of order recovery and the lack of the confirmed sustained recovery, combining with the computing market showing secular weakness. The market environment is a factor in driving weakness in the profitability of our Standard Products segment. However, our strong market positions in HPMS, in Identification, Automotive, basestations, as well as company-specific design wins in mobility supports our belief that we should again outgrow the market in 2013 with improved profitability.

Looking at the results for the first quarter of 2013, we can clearly see this trend demonstrated. The positives include the revenue performance of our HPMS segment, which delivered a stronger-than-expected quarter, primarily driven by Identification and some OEM order recovery in Automotive.

Additionally, we have had the positive settlement in our legal dispute, which resulted in onetime benefit of $43 million. The challenge in the quarter was clearly our Standard Products segment, which had a lackluster quarter in revenue, as we had projected, but much worse-than-expected profitability.

Turning now to our segment performance. HPMS revenue was $776 million, a 20% increase versus the same period a year ago, although a 1% decline versus the prior quarter and 2 percentage points above our original expectations. The continued performance in this focus area of our business is clearly encouraging.

Our identification business continues to perform very well, with new areas contributing to the growth. Revenue was $300 million, up 3% sequentially and up 60% year-on-year. This was above our original expectations for the quarter, driven by our strength in contactless banking in developing countries, but is also a reflection of NXP's overall leadership and the dynamic growth opportunity the security market offers.

Within our core ID business, revenue was up nearly 4%, driven by the continued strong demand for contactless banking products in Asia, offset by slight declines in the transportation in eGovernment, while tax and labor trends were flattish. Core ID represents approximately 70% -- 75% of overall ID. Within emerging ID, revenue was up nearly 3%, driven by flattish sales of mobile transaction products, offset by early revenue from authentication products.

During the quarter, we announced our next-generation of secure elements, the SmartMX2, the industry's first secure microcontroller to be awarded the common criteria EAL-6 security designation by the German BSI. The SmartMX2 builds on our industry-leading chip platform, the SmartMX, of which we have shipped over 1 billion devices to date. The SmartMX2 adds the physically uncloneable function, or PUF, which uses an innovative way of safeguarding individual chips from data theft by using the unique fingerprint inherent in every semiconductor device to protect its encryption key, thus making it very hard to clone or reverse engineer and compromise security of the device.

Now turning to our Automotive business. Revenue was $230 million, up 1% sequentially and flat versus the year-ago period. This was somewhat better than our original expectations, reflecting improved OEM order rates.

During the quarter, we achieved several milestones within our auto group. First, we signed a strategic collaboration with Delphi, a partner of our auto group for over 20 years. As part of this agreement, Delphi demonstrated its long-term commitment to NXP by selecting our SAF775x family, the industry's first single-chip RF CMOS multi-tuner car radio IC and NXP's AM/FM background tuner. Additionally, Delphi continues to be at the forefront of using NXP's software-defined radio for digital reception, such as the SAF36XX family.

Secondly, during the quarter, we achieved the 100-million-unit shipment milestone for our TEF66XX auto radio tuner family, which is now on low IF AM/FM single tuner with optional integrated RDS support. Of note, JVC KENWOOD, a leading car radio OEM and the very first customer to start mass production with this project, has taken shipment of 30 million units.

Lastly, we signed a joint collaborative agreement with Cisco Systems to invest in Cohda Wireless, a leading specialist in wireless communication for automotive safety applications. This agreement is recognition by Cisco of our leadership in the emerging market for car-to-car and car-to-infrastructure communications. NXP and Cohda Wireless have built a market-ready, flexible, wireless communications solution for onboard units based on Cohda's existing advance radio and NXP's market-proven, software-defined radio technology. This makes it a key element to connect to Cisco's vision of ubiquitous and highly secure Internet of everything.

Now turning to our Industrial & Infrastructure business. Revenue was $153 million, seasonally down 6% sequentially but up 6% versus the prior year. This was in line with our expectations of no real increased demand from the basestation OEMs. Additionally, we're excited with the design win opportunities we are seeing for our audio amplifier business.

Portable & Computing business, which now excludes revenue from GPL, which has more of the characteristics of our Standard Products segment revenue was $93 million, down 12% sequentially, but up 9% from the year-ago period, in line with our original expectations. The decline in our mobile design wins is below our original expectations, but we do anticipate a rebound combined with the new MCU opportunity to reaccelerate growth in the second half of the year.

Turning to our Standard Products segment. Revenue was $279 million, down 3% sequentially and up 2% versus the year-ago period. This was slightly worse than our original expectations, and we believe a reflection of the overall weak environment. In this area, overall market pricing is aggressive and remains a challenge for the segment.

Turning now to our distribution channel performance. Total NXP sales into and out of distribution were flat on a sequential basis. On hand inventory in the channel was essentially unchanged on a dollar basis. And we continue to operate the channel at 2.4 months of supply on hand, consistent with the levels we've been running for some time. Although there clearly are different levels of inventory by different businesses.

In summary, despite unacceptable performance in our Standard Products segment, we had good results for the first quarter with our HPMS segment, performing better than expected. We believe our HPMS segment business will continue to demonstrate revenue strength and improved profitability through the year. And getting Standard Products profitability back on track is clearly a focus priority. Now I'll turn the call over to Peter to discuss the quarterly financials in more detail.

Peter Kelly

Thanks, Rick, and good morning to everyone on today's call. Before I start, I'd like to mention that we recently announced that we have changed our segment reporting, and that we'll also be excluding stock-based comp from our non-GAAP reporting as we move forward. We made the segment reporting changes to better reflect the underlying trends in our business, our gross -- sorry, General Purpose Logic business line clearly has more in common, both from a gross margin and a go-to-market strategy with our Standard Products business than with our HPMS business. And our software business is used in support of our mobile business. Clearly, the GPL move is the much bigger change of the 2.

Now we've also decided to exclude stock-based comp from our non-GAAP numbers. We'll continue to give you full visibility on the impact of this, but believe this change will give you a better view of the underlying performance of our business, as well as make this more directly comparable with key peers.

Finally, as this is a transition quarter, I will try to bridge between the old reporting and the new reporting to ensure you have the opportunity to understand what is happening. And I'll also try and anticipate some of the more obvious questions. Hopefully, I'm not confused anymore, and I apologize in advance if I appear to be spoonfeeding obvious data.

Overall, we delivered a good quarter, reflecting better top line revenue trends than originally expected. We delivered non-GAAP earnings of $0.72, continue to pay down debt, as well as completing 2 debt transactions, which convert at about $1 billion of floating rate secured debt to fixed rate unsecured debt.

And now turning to the specifics of the quarter. Top line revenue was $1.085 billion, down 3% versus the fourth quarter, but at the top end of our guidance. We generated $537 million in non-GAAP gross profit of 49.5% non-GAAP gross margin.

During the quarter, an ongoing legal dispute was resolved in our favor, which resulted in a $43.5 million net benefit to cost of goods. Excluding the onetime benefit, non-GAAP gross profit was 45.5%, which was below our target due to several items in our Standard Products segment, which I'll discuss in a moment.

Total operating expenses was $289 million or about $2.5 million better than our original guidance, excluding $16 million in stock option expense, including in operating expenses. This resulted in non-GAAP operating profit of $255 million or 23.5%.

So let me turn to the segment performance. Within our HPMS segment, revenue was $776 million, down 1% versus the prior period, but approximately $14 million better than our target. HPMS non-GAAP gross profit was $465 million or 59.9%. Our non-GAAP operating profit was $229 million or 29.5%, 520 basis points higher sequentially. Excluding the $43.5 million one-off onetime legal dispute, HPMS non-GAAP gross profit would've been 54.3%, 20 basis points lower than the prior quarter.

In our Standard Products segment, which is now the combination of our General Purpose Logic and discrete businesses, revenue was $279 million, down 3% sequentially and approximately $8 million below our target. Standard Products segment non-GAAP gross profit was $73 million, or 26.2%, about $18 million or 6.5 -- sorry, 650 basis points below our target. While revenue in the Logic business was a bit lower than expected, gross profit fall-through was essentially as we expected.

Within our Standard Products business, about half the impact of gross margin was due to poor product mix and a tougher pricing environment. The remaining shortfall was due to poor operational performance, with lower absorption than planned and a slower ramp up in our factories, following the quality issues reported in Q4 and a slower return to work in our factories, following the Chinese New Year. We are diligently working to address the issues within our control but do not expect an immediate improvement in the business.

Standard Products segment non-GAAP operating profit was $28 million or 10%. Interest expense was $49 million, slightly better than expected. Noncontrolling interest was $13 million, in line with our guidance, and cash taxes were $7 million or $2 million, better than expected.

Taken together, our non-GAAP earnings per share was $0.72, of which about $0.17 was due to the legal dispute benefit and about $0.07 was stock-based compensation. Net of these items, earnings per share was $0.49 per share, which was in line with the midpoint of our guidance.

Now I'd like to turn to the changes in our cash and debt. Our total debt to the end of the first quarter was $3.44 billion, down $52 million from the fourth quarter. During the quarter, we completed 2 $500 million unsecured note transactions using the proceeds to pay -- to repay $962 million in secured floating rate term loans. Both of the new bonds carry fixed interest of 5.75% and are due in 2021 and 2023 respectively.

While the refinancing actions do not materially change our expense outlook, they do derisk and extend our debt maturity profile. And we continue to see interest expense in the $195 million range this year and are committed to our deleveraging programs. Cash at the end of the quarter was $595 million down $22 million sequentially. We exited the quarter with net debt of $2.8 billion on a trailing 12-month adjusted EBITDA of $1.2 billion, resulting in a net debt to trailing 12-month adjusted EBITDA leverage ratio of 2.4x.

You will note that we bought back 1.1 million shares at a cost of $35 million. I want to assure you that we're still very much focused on paying down our debt, but to the extent that we receive proceeds from the exercise options, we will use these receipts to offset any dilution.

You will also note that our overall non-GAAP fully diluted share count increased from 254 million for the fourth quarter to 257.8 million shares for the first quarter. This reflects the almost 25% increase in the average share price of NXP from Q4 to Q1.

Turning to our working capital metrics. Days of inventory were 111, an increase of 7 days. Receivable days were 39, up 1 day, while payable days was 78, down 4 days, resulting in a cash conversion cycle of 72 days, up 12 days from the prior quarter and reflecting seasonably lower revenue in Q1 and planned revenue growth in Q2. Cash flow from operations was $119 million, and net CapEx was $39 million, resulting in a $80 million -- resulting in $80 million of free cash flow or approximately 7% free cash flow margin.

Now I'd like to provide our outlook for the second quarter. Influencing our outlook 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 6% to up 12% sequentially. At the midpoint of this range, of 9% sequentially, we anticipate the following trends, all on a percentage point basis.

Within our HPMS segment, we expect Identification revenue to be up in the low double-digit range. Within our Automotive business, we expect revenue to be up in the single-digit range. Within Infrastructure & Industrial business, we expect revenues to be up in the low teens range. And we anticipate in our Portable & Computing business to be up about 10%. Within our Standard Products segment, we anticipate low- to mid-single digit sequential growth. We anticipate the combination of manufacturing and Corporate and Other to be around $26 million. And taken together, total NXP revenues should be in the range of approximately $1.15 billion to $1.21 billion, or $1.179 billion at the midpoint, up about 9% sequentially.

We expect non-GAAP gross profit to be about 46%. We expect operating expenses to increase by about $10 million and to be about $300 million, plus or minus $5 million as we plan to accelerate certain development investments within ID to continue to reinforce our market leadership position.

Taken together, our guidance should into a non-GAAP operating profit in the range of $237 million to $258 million. Interest expense on our debt should be approximately $48 million, cash taxes roughly $12 million and noncontrolling interest expense should be about $17 million. Stock-based compensation should be about $20 million, which is excluded from our guidance.

Diluted share count should be about 259 million shares, depending on share price fluctuations. Taken together, this translates into earnings per share of $0.62 to $0.70, or $0.66 per share at the midpoint of our guidance range. Clearly, our profit and EPS guidance is below where we would've liked it to be, given our improvement in the sequential revenue growth. We are very comfortable with the performance of our HPMS business, but our Standard Products business is at a tough quarter. And we believe, at this point, it's responsible not to forecast the snapback in Q2.

Finally, I'm sure you'll be wondering what the status is of our goal of exiting 2013 at 25% EBIT. Clearly, I don't want to give guidance for Q4. However, I would like to say the following. Firstly, the exclusion of stock-based comp is not part of our plan to get to 25%. Without stock-based compensation, the comparable number is 26%. Secondly, our HPMS business is clearly on track with what we've discussed in the recent past. I believe that our Standard Products team can get their profitability back on track during 2013, so we feel no reason to back off our goal.

I'd like to now turn it back over to your questions. Jeff?

Jeff Palmer

Shequana, could we poll for Q&A please?

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes on the line of John Pitzer, representing Credit Suisse.

John W. Pitzer - Crédit Suisse AG, Research Division

Peter, I'm sorry if I missed this, but did you tell us how much General Purpose Logic revenue got reclassified into Standard Products was about? $80 million to $85 million?

Peter Kelly

Yes, probably John, [ph] yes.

John W. Pitzer - Crédit Suisse AG, Research Division

And then in that bucket, can you help us understand a little bit better about what forces, you think, are driving such a weak pricing environment? And if -- could you help us understand how the gross margins you expect to trend sequentially in Standard Products in the June quarter? And then I have a follow-up.

Peter Kelly

Yes. So the -- what we're assuming is basically our gross margins in Standard -- the Standard Products segment will be about flat as we go from Q1 into Q2. So clearly, a tough quarter, but we had assumed that it would improve by about 300 basis points, and clearly it didn't. So the gap from where we expected it to be in Q1 was about $18 million. Now half of that was, let's say, market driven, and half, it was an internal issue. So the bit that was market driven, clearly, Standard Products has seen some impact from what's going on in the computing industry, in particular. But also, I had a pretty weak mix of products. Although we got there on revenue in terms of what we said, the actual mix of product that they shipped was much weaker than we originally planned. And they're just -- they're just not seen a very strong underlying -- let's call it, underlying semiconductor market at the moment. In terms of the issues we had internally, they were really around couple of things. I mentioned that we had a quality problem in one of our back ends during Q4. As we try to, or as we ramped our production back up in Q1, we decided to be quite conservative in how we brought our factory up and err on the side of caution. So the yields are not as good as we would like them to be. And the output's not as good as we'd like it to be. But we thought it's more important to ship our usual export levels of quality than make a compromise there. And do you think I can get that -- or we can get that back on track in the second half of 2013. But I just -- given what we said on the last call, I just thought it was -- it made more sense to be conservative and make sure we do have the opportunity to get it back on track without forecast and a big leap in performance.

John W. Pitzer - Crédit Suisse AG, Research Division

Guys, as my as follow-up, Rick, clearly for the last 3 or 4 quarters, you guys have been significantly outgrowing the industry, benefiting from some sort of -- from some company-specific product cycles. I'm kind of curious, as you think about the June guidance and the balance of the year, if you could give us some help understanding what inning you think we're in for some of those key products cycles, specifically, authentication, the microcontroller sensor hub and the emerging ID NFC business?

Richard L. Clemmer

Yes. We continue to believe that we can continue to outgrow the market by at least 50%. So we haven't backed off that at all. And I think, clearly, our performance over the last few quarters demonstrates that capability. And at least with what we've seen on guidance for the -- for Q2, it looks like we feel pretty good about continuing to be at that 50% greater than the industry. If you look at where we're at, a wide range of growth. I mean, clearly, on the microcontroller, on the sensor hub, that won't start shipping until midyear, so there's nothing in there. So it's kind of -- we're up to bat. I wouldn't call it an inning yet. But we're -- we feel good about the opportunity, but, clearly, no shipments yet whatsoever. In our ID business, our ID business continues to have strong double-digit growth. We continue to feel very good about that. One of the things that really gives us the strength is the diversity of our portfolio. While we may have some things that are slowing somewhat relative to the design wins or whatever, we have other items where we see a strong rebound or a strong growth coming in, which helps drive the overall double-digit growth consistently in our security business and really put us in a good solid position. So one of the key areas is authentication that we've talked about. It's kind of in the first inning. Have a really critical design win that's going through an internal ramp up with a service provider, so that they can confirm the actual benefits and capability. And then if we're successful with that, as we certainly believe we can be, represents a significant opportunity for us. In addition to that, we're seeing some real momentum in some of the device authentication beyond just the cybersecurity authentication to the cloud. So we feel good about the authentication side, but we're clearly in early innings. Maybe first inning, second inning, looking at it. In the case of NFC, we're probably in the second or third inning, something like that. I mean, clearly, the strength of the 100 million plus units we shipped in 2012 and continuing to move into 2013, we feel good about with what is it now, up to 200?

Peter Kelly

150.

Richard L. Clemmer

150 different handsets and tablets that have designed in our NFC product, and we continue to see continued momentum associated with that. And especially as we talk about the secure element and the opportunity it brings to the market, combined with the strong intellectual property portfolio that we had associated with NFC. So we're still, clearly, in early innings. When you start talking about the future, like in the 2015 timeframe, most of the analysts now are talking about half the smartphones being NFC-enabled by that point in time, so a lot of growth opportunities there. And really all of that combines and comes together to give us the comfort associated with the double-digit growth associated with our ID business. But we should also reflect on the fact that the most recent quarter was a 60% annual growth versus a year ago, so clearly, strong growth associated with that. And then, clearly, the opportunity in basestations, if the service providers ever get around to really expanding their quality of service where there isn't so many dropped calls, we think that it will continue to expand the CapEx investment. And with our design win, market share associated with 3G and LTE, it should put us in an excellent position associated with revenue increases associated with that as well, John.

Operator

Your next question comes from the line of Blayne Curtis, representing Barclays.

Blayne Curtis - Barclays Capital, Research Division

Rick, your comments on the kind of overall market in I&I were fairly tempered, but obviously, that's where the strongest growth is. So can you just talk about the drivers that you're seeing into June there?

Richard L. Clemmer

Yes, so one of the things that we have found is in addition to being totally unpredictable with the basestation OEMs, it becomes fairly seasonal. And so we clearly have a seasonal uptick in I&I associated with the basestations' shipments. We also have some significant design wins in our LNAs, in our small-signal business, in different design wins that we'll be ramping. While it's not such a large dollar item, we have won a number of significant design wins that continues to position us well. And then the ramp up of our mobile audio processor, where we have a number of design wins, including -- I don't know that we can talk about the specifics of those, but, really, a solid design wins, where the fundamental quality of sound is being recognized in those specific handsets, facilitated our Maximus [ph] processor associated with it. So that's really what drives the growth associated with I&I. And it comes as much as anything from just the seasonal basis associated with the basestation OEMs.

Blayne Curtis - Barclays Capital, Research Division

And then the answer to prior question, it sounded like authentication's still in the early stages. Obviously, you're weathering a share loss -- a well-known share loss there fairly well. Can you talk about between core ID and emerging, where are you seeing the stronger tailwind into June? And as far as whether you can comment on your kind of -- the growth of core ID, which I think gets overlooked but has been a pretty strong part of your business.

Richard L. Clemmer

I think we clearly just talked about, for the most recent quarter, and our core ID business grew 4% sequentially, while emerging market grew at kind of 3%, so they both -- on a sequential basis. So they both had a pretty reasonable growth associated with a given seasonal -- seasonally weak Q1 period. And we expect to see double-digit growth for Q2. That's facilitated by a broad array of the portfolio associated with ID. And we still feel very good about that growth and the opportunity to continue to contribute to the overall growth of our High Performance Mixed Signal segment.

Operator

Your next question comes from the line of Steve Smigie, representing Raymond James.

Jonathan Steven Smigie - Raymond James & Associates, Inc., Research Division

I suppose you guys could give a little bit more color on some of the comments you made in your prepared remarks, released in the press release, about taking necessary actions in the Standard Products business and also on the R&D acceleration. So I guess on the Standard Products, I mean, it sounds like basically you just try to be careful about ramping the quality issues, but is it more than that? And then on the R&D, what sort of impact should we think about for that R&D acceleration you talked about as we look out to Q3, Q4? Should we have seen some sort of dollar change or percentage of revenue change?

Peter Kelly

I think on the -- sorry, it's Peter Kelly. On the factories, it's -- in our Standard Products business, we have 2 really big back ends, so we don't source our product from multiple areas. One -- if one of the sites is off, it has quite a big impact. It's really related to how fast we can bring the yields back up. And we have a lot of people working very, very diligently in order to do that. But -- and it's the usual kind of things that you would do to do that. So it's really, really focused about how we -- not how we improve our yields to a whole new level, how do we bring our yields back to what we're used to them running about. So that's really on the manufacturing issues for Standard Products. In terms of R&D, I don't really want to get into forecasting Q3, Q4 R&D. In terms of the model, we'd expect our -- I think what we said in the past is we'd expect our SG&A to run about roughly 12%, maybe 11.5% in our R&D to run 13.5% or 14%. So we have a top OpEx of around 25%, which is where we're trying to get to.

Richard L. Clemmer

So if you really look at that in ID, what we're doing is we're pulling in some of the investment increases that we've planned later in the year to be able to ensure that we can protect the leadership technology position that we have and secure the technology advantages to be able to continue to go drive, continue design win improvements. And we're not talking about tens of millions of dollars on the quarter -- on that quarterly increase, but we're talking about clearly a step up of OpEx that will have an impact on our operating income on a single-quarter basis. But it won't really drive any increase in OpEx out in the second half of the year as we're just pulling it in as opposed to continuing to increase it. And if I could just add on, on the Standard Products, basically, we just got to get back to the basics of the business. Our combination of our operational performance, which in our back ends was not good this year, especially with the ramp up after the Lunar New Year coming back and some of the quality issues, we've got to ensure that we can get those fixed and be able to move forward. And the market environment, specifically in that area, has been clearly weaker than we would have anticipated, not to dissimilar to what we saw last year in the first quarter of the year where we've been some more of a moderation through the rest of the year. But our focus is how we get back on a reasonable profitability and drive the operating income of this business back more towards the entitlement [ph] ranges that what we believe it can perform at.

Jonathan Steven Smigie - Raymond James & Associates, Inc., Research Division

Okay, great. And just in terms of the core ID business, can you give any color on rollouts of programs for, say, government ID? Obviously, you had it in Indonesia win. Where are we for that and how quickly might sort of any big Chinese program turn for you?

Richard L. Clemmer

So I think it's not just on the eGovernment side. I mean, the eGov part specifically has its puts and takes on a quarterly basis. We clearly won a couple of significant countries in the most recent quarter, but we always do. So that's not really anything that's specific. Clearly, the area that we're seeing the most significant opportunity in near term, which helps us and really is the reason, again, that I mentioned, the strength of the portfolio, is in the rollout of contactless banking in China and the relationship we have with a number of different institutions to be able to facilitate that. We're basically -- they're skipping some of the intermediate steps of -- that other countries have gone through on the banking and moving to this contactless banking in a very strong position, and basically being able to facilitate with our technology and drive a much easier use with a much more secured basis.

Operator

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

Christopher Caso - Susquehanna Financial Group, LLLP, Research Division

I just wondered if you could just give a little more perspective on the Standard Products business right now with respect to the underperformance there from a revenue standpoint. Is there anything in particular that you could point to there? Again, as you look at perhaps this time last year, I think the business was performing a little bit better at this point in the calendar. Is this -- have somewhat to do with what's happening in the PC market right now? Do you see that kind of an overall proxy for what's going on in the market overall? And then as a follow-on to that, what do you typically see in terms of seasonality for that business? In other words, just should there be a natural tailwind as we go into the back half of the year?

Richard L. Clemmer

So I think the one thing that's clearly different in that business is the computing segment. When you really get down to it, there's probably a higher share of product mix in that business and the rest of our business that goes in the computing space. And clearly, the headwinds in computing that are -- had been very clearly stated creates some headwinds. We set an objective, a strategic objective, 1.5 years ago or so, to really change more towards the infrastructure and automotive side, as we have very strong automotive position in that business, but -- and we have the design wins. And interestingly enough, it is design wins when we start talking about Standard Products and Automotive to be able to facilitate that. But they have -- there's still quite a long period of time from when you win the design win to the ramp up associated with that revenue. But in the near term, the most significant thing has been the weakness on the computing market, and not dissimilar to what we saw in first quarter of 2012, very significant price pressure associated with the business. If we look at what happened in the rest of 2012, we saw more of a moderation of the pricing environment in the -- in quarter 2, through quarter 4. The question is, will we see that same kind of moderation in 2013 as well? And we think that part of that depends on clearly the economic underpinnings are the general economic environment, which we still have not seen a truly robust recovery across the board. If you look at own seasonality, the Standard Products business is typically pretty weak in Q1 and then we see improvements throughout the year. And then Q4, it's kind of flattish to roll off slightly from the Q3 range. But Q3 is typically clearly a better quarter for us, but it has a little bit of a -- it's not quite as much as the rest of our business just because of the Automotive share of Standard Products as well.

Christopher Caso - Susquehanna Financial Group, LLLP, Research Division

Right. Okay, that's good color. And just with respect to the distribution channel, I think you talked about a sell-in and sell-through was about flat in the first quarter. What are you anticipating to happen in the second quarter with the distribution channel? And specifically, are there any signs of restocking going on in the distribution channel, given the low levels of inventory right now?

Richard L. Clemmer

Well, so I think we have to be careful about low levels of inventory. Our inventories remained at 2.4 months consistently with I think one exception over the last 5 or 6 quarters. So our inventory levels have not changed significantly. The one thing that has changed is the mix. So we have some business like Automotive where our inventory has gone down in the distribution channel in the most recent quarter, while we have other areas like ID and high-performance RF, where there actually been a little bit of increase in channel inventory in preparation of design wins that they've won in those shipments beginning to take place in Q2. So I think clearly, we're optimistic about Q2. I think it's always an arm wrestling with our distribution channel partners. We'd like to see them carry more inventory, more like moving towards 3 months of inventory, and they'd like to be less focused on their turns-and-earns basis. But I think the key factor is, is looking at the total. And the fact is that we've been at 2.4 months of inventory for, as I recall, like 6 out of last 7 quarters or so. So we don't see a significant change, although we see some significant changes by products within that overall mix. But clearly, we see orders improving associated with distribution, and we're quite optimistic about Q2, obviously, consistent with the guidance that we set associated with the 6% to 12% product revenue increase.

Operator

Your next question comes from the line of Jim Covello, representing Goldman Sachs.

James Covello - Goldman Sachs Group Inc., Research Division

If you guys have a terrific HPMS business, it's growing faster than it appears, it's got good margins. The story in the multiple on your stock though is being held by the issues in Standard Products, not just this quarter but over -- intermittently, over the last 18 months or so. Obviously, you believe you can fix those issues. You're reiterating the 25% EBITDA targets for the year. Is there a point at which if you can't fix those issues, as you go through the remainder of 2013, you would consider exiting the Standard Products business to taking the cash for that, paying down the debt and being left with a very high growth, high-margin HPMS business?

Richard L. Clemmer

Well, Jim, we've been very specific on our Standard Products business that our focus is on High Performance Mixed Signal, it's not the strategic part of our business. I guess with the change with GPL, it's still only 25% or so of our total revenue associated with it. I think that we have talked about the relationships that it brings. And specifically in Automotive, in fact, we were just notified this week that we won a quality award from one of our largest Automotive customers, again, in Standard Products. So it does have a positive aspect associated with it, but it's clearly not a strategic business for us. But frankly, we're quite confident that we can fix it. And we think that we should fix it, and then we'll decide how we move forward over the longer term. But there's -- we don't think that it hinders our overall financial performance going forward in any way, and we clearly believe that the operating income objectives that we've set for exiting this year at 25% before the change, or as Peter said, even reflecting the share equity cost at around 26% is not a changed at all with that process, Jim. So we feel like that it's just basic blocking and tackling that we've got to take care of. We had a number of operational issues in the quarter and a number of plants with quality and labor issues that we have to work our way through. But the bottom line is, is that we have to get those fixed and get back on track, which we feel very comfortable that we will be able to accomplish.

James Covello - Goldman Sachs Group Inc., Research Division

Thoughtful perspective. For my follow-up, on the Portable & Computing business, I think the guidance there is stronger than the market would've expected, given well-documented weakness at one customer that you had. Are you gaining share at some customers that might offset their own issues? Or you're getting shares outside of those customers? Or did you take the kind of pain from the issues that customer is having in the first quarter, as that business was down about 12% or so? Could you give us a little prospectively on your ability to guide up there?

Richard L. Clemmer

Well, we feel pretty comfortable about the guidance that we have associated with it. It's a combination of things, it's not all into any individual customer associated with it. What we did say is, clearly, the revenue expectations we would've had 3, 4 quarters ago are higher than what we have achieved in Q1 or frankly even our guidance in Q2. But we feel very good about the relationship with those customers that are focused in, that are waiting in that area. And think we can continue to drive that business going forward. And there will always be quarterly bumps along the way, but on a sustained basis, we feel very comfortable with the position that we have with design winds and the customer support for those key customers in that area.

Operator

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

Ross Seymore - Deutsche Bank AG, Research Division

Just to follow-up on that last one, does the guidance of -- I think, you said low double-digit growth in the Portable & Computing area, include the benefit of the beginning of the sensor hub/MCU business? Or is that still more in the second half of the year?

Richard L. Clemmer

There might be some early initial shipments, Ross, but it's not a significant factor associated with the guidance. But there'll be only early shipments, a little bit like we had on the interface product kind of in the second quarter of last year, but it's not really a significant factor in the guidance.

Ross Seymore - Deutsche Bank AG, Research Division

Got you. And then for my follow-up, more on to the margin side of things. If I'm doing my math correctly with your flat Standard Product gross margin in the second quarter, it seems like x the gain you had in the first quarter that the HPMS gross margin is also relatively flat, may be even slightly down sequentially. Can you just talk about with the puts and takes are for the HPMS gross margin as we look into the second quarter?

Peter Kelly

I think the -- or maybe my math is wrong, but I think the HPMS gross margin is up a little bit, Ross, but not a lot, okay. I think we have lots -- you have lots of moving parts going on in there. So it's -- I mean, I don't think there's anything special going on in gross margin from Q1 to Q2 in HPMS. I think that fundamental issue for the company is if Standard Products was forecasting where -- sorry, if Standard Products was performing where we wanted it to be. It would probably be 150, maybe 180 basis points higher on gross margin and operating margin than we've currently got in the forecast, and we'd be looking at something more like 47.5 as a whole -- company as a whole, and I think people feel very comfortable. So I think our HPMS margins are pretty much on track I'd say.

Richard L. Clemmer

Yes, I guess that you always, Ross, have a mix on a quarter-by-quarter basis. Clearly, some of the ramp up on the contactless banking isn't necessarily as profitable as some of the rest of our security business, so there's always puts and takes. I think the bottom line operating income performance in HPMS clearly demonstrates the capability that we have and puts us on a pretty good track to be able to exit the year at the objective that we've established.

Operator

Your next question comes of the line of David Phipps, representing Citi.

David Phipps

On some of the capital allocation issues, to accelerate your move towards investment grade, would you consider paying down debt a little bit more rapidly to encourage the agencies at the same time that you're buying back stock?

Peter Kelly

Well, in the stock buybacks, there were early buyback stock to the extent that we get receipts from stock option, except for people exercising their stock option, so it's pretty small amount of money. We do plan to use basically all of our free cash to pay down debt in the coming year. There's no change on that.

David Phipps

And there were used -- but you have some drawings on the revolver, would we expect to see those repaid by the end of the quarter?

Peter Kelly

Yes, we kind of moved the revolver around as our -- as we see fit. There's not a lot of point in -- there's almost -- you make nothing on the deposits, so we try and keep our revolver as low as possible here. So the big thing coming up is just over $0.25 billion debt due in late summer this year. And that's the kind of next chunk of debt that we need to go or we need to go after, and we're planning to pay that then.

Richard L. Clemmer

I think you should look at the progress that we've made on our debt-to-EBITDA basis. We continue to improve that through a combination of improved EBITDA, but also through the reduced net debt. And Peter has talked about that fact that we'll continue to generate cash and focus on paying down our debt. But it's a number of quarters that you can count on one hand that we'll be in the position where we'll have our net debt that's down at the 2x annualized EBITDA basis. But as far as what the credit agencies do relative to ratings, they have to set that on their own pace.

Operator

Your next question comes of the line of Vikar Arajay (sic) [Vivek Arya], representing Bank of America Merrill Lynch.

Vivek Arya - BofA Merrill Lynch, Research Division

Rick, I think it's good to see the Auto segment starting to grow again. How should we think about it conceptually for the year, given some of the sluggish data points around European and China auto sales? And if you could remind us of your relative geographic exposure?

Richard L. Clemmer

Well, I think our -- in Automotive specifically, our geography exposure is pretty well consistent with the Automotive industry. And it's really hard for us to track, because when we ship a product, we don't know who that end market is that they're actually going to consume it based on a number of our customers. I think it's probably worthwhile to point out that the strength of the OEM orders that we saw in Automotive were clearly in Korea and in Japan and China, and we didn't see any real improvement in Europe and in North America. So our strength in Automotive was clearly in Asia, and that's where we saw the improvement associated with it. But -- and we've always said that we would anticipate the growth in Automotive segment this year to be in the developing countries and not in North America and Europe associated with it. And I think we don't see anything that changes that at all, although it is good to see a strength in OEM order rates in Automotive in total.

Vivek Arya - BofA Merrill Lynch, Research Division

And as a follow-up, Peter, I wanted to revisit this gross margin issue in HPMS. I think your sales were up 20% year-on-year and HPMS gross margins were roughly flattish, but operating margins were up almost 500 basis points. So is it time to rethink the expectation you have set around what the gross margin and operating margin target should be, longer-term for this segment? Is it a mix issue that more of the growth has been driven by OEMs, more consumer products, so we should have different expectations in terms of gross margin and operating margins for this segment?

Peter Kelly

I think the expectation that in terms of 26% OI is a reasonable one. We clearly need to increase or improve our gross margins by -- we think by about 300 basis points. Obviously, the Standard Products issue is has caused us a slight bump. And we need to take OpEx down a little bit. But I think the -- it's reasonable to focus on, on certainly as the first step an operating income of 26% there. I think once we get there, then we can talk about changing the target, but I'd be uncomfortable trying to increase the target before that. I guess one other thing I was just looking as well, I'd like to apologize to Ross, I was look at operating margin when I answered Ross' question. So HPMS margin, if you do the math on our guidance, would be down a little bit. And as Rick mentioned, that's really a mix issue and reflects the larger chunk of our business coming from contactless banking in Q2. So sorry about that, Ross.

Richard L. Clemmer

And you know, I think the mix of gross margin and operating income is interesting, but I don't think we're really wanting to change our overall model because we think, for the long term, it's still -- it's in effect. And the key is for us to be able to run at the 26% operating income on a sustained basis exiting the year, and be in a position where we can continue to deliver on that with above the industry growth rates, which drives a very compelling earnings improvement going forward.

Vivek Arya - BofA Merrill Lynch, Research Division

All right. And just one last question, Rick. On the emerging ID business, NFC was a key part of growth last year and there were some notable design wins away especially at Samsung, but you're still sounding relatively confident about the business of CRM. Wondering why that is, given that mode of the NFC radio part, is being integrated in combos, especially at Samsung. So the number of design wins you mentioned in smartphones, is it in customers other than Samsung? Is it still within Samsung? And even if you cannot be customer-specific, I'm just curious how you're confident about growing the NFC business this year, given the changes? And how NFC is being adopted by different smartphone customers?

Richard L. Clemmer

Well, so I think is worthwhile to point out that we still have design wins across the board at all major customers associated with it that are using NFC. So I don't think we -- we're certainly not backing off of our -- the strength of technology and leadership position that we have. What we've always said is, eventually, there'll be an integration on the radio. And our objective is to be sure that we can provide the secure element associated with it. And we clearly see that playing out, although it's played out at a little bit slower rate than what we had expected several years ago. So we clearly see that, but really the strength of our security businesses is the breath of our portfolio and the strong technical leadership position that we have as a company that can continue to bring some unique capabilities to all of our customers to provide security in a fashion that few semiconductor companies are in a position to be able to accomplish. And so, that strength of that portfolio is really what drives our ID business and the confidence we have in double-digit growth and the strength that we continue to see where we have outperformed clearly and can continue to be in a strong leadership position going forward.

Operator

Your next question comes of the line of Will Stern (sic) [Will Stein], representing SunTrust.

William Stein - SunTrust Robinson Humphrey, Inc., Research Division

It's Will Stein from SunTrust. First, I'm wondering if you can comment on capital allocation plan post 2x net leverage, it's a point that I think you've mentioned in the past. Do you still expect to get there by the end of this year? And remind us about your intended use of cash flow following that time?

Richard L. Clemmer

Well, we've been very specific that we're going to look at what's in the best interest of shareholders when we get below 2x the annualized EBITDA on net debt. So we'll look at that at that point in time. Our clear focus is on how we continue to reduce the debt over the next 3, 4, 5 quarters to be in a position to be sure that we get to that 2x annualized EBITDA. But as far as going beyond that, yes, it's premature for us to say. We want to look at it and what drives the best return for our shareholders at that point in time. But clearly, there is no lack of focus in being able to continue to pay down our debt in the next few quarters.

Peter Kelly

Yes. I think Rick's comment in that we'll do what's ever in the best interest of our shareholders, is one that's worth emphasizing. We spent a lot of time talking to our shareholders, and Jeff mentioned all the conferences we're going to be at in the next couple of months. But we -- when we get to that point, we will listen to our owners, so people like yourself, and we'll decide what's the best thing for the shareholders. So there's lots of different options, but in the meantime, we need to focus on paying down the debt.

William Stein - SunTrust Robinson Humphrey, Inc., Research Division

That's helpful. And if I can just ask another question about Automotive. I think historically, the company's strength has been in radios, and you highlighted a few customers in that part of -- that part of Automotive. And you also talked about a new relationship, you have co-funding a company with Cisco. Can you talk about when you see car-to-car and car-to-infrastructure demand ramping and becoming a noticeable contributor to that end market?

Richard L. Clemmer

So you know that's out several years, that's not something that we can really drive a specific growth commitment associated with. The key for us is to be in a position to continue to be a technology leader associated with it. And I think the relationship that we announced with Cohda, as well as Cisco, continues to confirm the strength of that position. There are field trials that are going on today on car-to-car and car-to-x communications. The ability to drive that and maybe some of the innovation to be able to facilitate aftermarket implementations may drive that sooner than it would be on just a individual car basis. But clearly, the discussions that we have with Automotive companies on some of their high-end cars, they're talking about that in -- out a few years. But as anything that's a really new emerging technology in automotive industry, it takes a long time, a number of years, for it to develop into a significant revenue growth. And the one thing I'd like to point out, you're right, we are the leader in car infotainment, specifically associated with our radios. But on our safety and comfort business, we have a very strong leadership position in the remote keyless entry where basically every car that's manufactured in the world, with exception of Toyota, uses our technology and a few models of Volkswagen. So that gives us a clear strength as well as the in-vehicle networking associated with it and some of the Lighting areas. So we have a number of different areas where we're uniquely positioned in a strong leadership position outside of just the car radio itself.

Operator

Your next question comes from the line of Vijay Rasheet (sic) [Vijay Rakesh], representing Sterne Agee.

Vijay R. Rakesh - Sterne Agee & Leach Inc., Research Division

I just had one question here. If you look at the operating margin, obviously, 21% here for June. But as you look at exiting the year at 25%, 26%, what are the levers you are seeing? Is that more on the -- you see the gross margin side or is it OpEx? If you can give some more color on how you see the nice snap back on the second half?

Peter Kelly

Okay. So it's a couple of things. One is I'm absolutely not going to give guidance for Q4. But from what we've talked about in the past is we need to improve our gross margins by about 300 basis points and our OpEx by about 200 basis points. So our OpEx, we took a big charge in Q4 and we're diligently implementing that plan, so I have a high degree of confidence on OpEx. And gross margin relates to 3 general areas: One is, it relates to our wafer costs; the second relates to kind of basic blocking and tackling around yield and design; and third area related to we expect by towards the end of the year to be able to get a more reliable and consistent IP revenue stream, which is something we've been working on for the past few years, actually. So nothing changed there. The only fly in the ointment at the moment is our Standard Products performance. As we've described, we think we can get that back on track for the second half of the year.

Jeff Palmer

Thank you. Well, thank you, everyone, for your interest in the company today, and we look forward to speaking with you at another time. Rick, would you have some closing remarks you'd like to make?

Richard L. Clemmer

Yes. Thanks, Jeff. We continue to be focused on improving our overall profitability, delivering improved earnings, outgrowing the market in revenue and maximizing shareholder value. We are confident that we will execute the plan, although we will accelerate some investments in ID that had been planned for later in the year to ensure continued technology leadership. We are also very focused in taking the necessary actions to improve the performance of Standard Products segments, which has clearly been disappointing. Our strategy continues to be focused on providing unique and differentiated product solutions to enable our customers' success, which over the long term, will allow NXP to continue to outpace the cyclical growth of the overall semiconductor market and deliver superior profitability with strong EPS growth. Thank you very much.

Jeff Palmer

Thank you very much for your interest. Take care.

Operator

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect, and have a great day.

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NXP Semiconductors (NXPI): Q1 EPS of $0.72 beats by $0.23. Revenue of $1.09B beats by $0.02B. (PR)