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NXP Semiconductors (NASDAQ:NXPI)

Barclays Global Technology, Media and Telecommunications Conference

May 22, 2013 11:40 am ET

Executives

Jeff Palmer - Vice President of Investor Relations

Analysts

Blayne Curtis - Barclays Capital, Research Division

Blayne Curtis - Barclays Capital, Research Division

Hey, welcome. My name is Blayne Curtis, I'm the [indiscernible] analyst here at Barclays, very happy to have NXP Semiconductors. From the company, I have, Jeff Palmer, from Investor Relations. Thanks for joining.

Jeff Palmer

Thanks very much, Blayne. Glad to be here.

Blayne Curtis - Barclays Capital, Research Division

NXP has been our top pick. I think it has an interesting combination of both top line growth, gross margin leverage, deleveraging of the balance sheet. One of the best relative valuations I thought may we talk about the first 3 and maybe help out the ladder there. But maybe just getting started, this will be a fireside. Happy to take any questions. Raise your hands and we'll get to those. But maybe, Jeff, I think most people know the story but maybe just real quick, you just walk through, just a little bit, the spin out of off from Philips. Then kind of maybe -- but just focus on really high level, what's the core competency and kind of what's the story.

Jeff Palmer

Yes. I think it's great set up point, thank you very much. So as you -- as Blayne alluded, we got spun out of Philips in 2006. Stayed private until like 2010. During the course of that period, we refocused our business on areas where we could be significant leaders. Those areas tend to be areas of expertise in RF design, microcontroller design, mixed-signal, analog, digital design, security, low-power design. We got rid of some divisions that were underperforming and we were basically never going to be a significant player. So we divested of our Cellular Baseband business, divested as a Digital TV Business, as well as a men's speaker business in 2011. So really kind of refocusing down on areas where we could be a leader, not just #1 but where we could have a relative market share of at least 50% relative to our next competitor. I think if you look at our total revenue of about $4 billion, about half of that revenue we are clearly achieved that. We're #1 leader. We have a very wide margin of relative market share. We've got probably 20% of the rest of the business where we're -- we've got a shot of becoming a leader, and then a good portion of this but we're still actively working hard to gain the market share. In terms of things that are driving the business over the next couple of years, the whole move toward security, both securing people and securing things has been a huge driver of our business. Our Identity business now is almost $1 billion a year in revenue. And to put that in context, short 4 years ago, it was only $300 million a year. So 4 short years, it grown almost 3x. The things that we do in Identity that are really key and unique to the company is, we do government passports and identity cards, automatic fare collection, contact with banking, infrastructure and mobile transaction. All areas where we believe we're leaders. Second very large kind of a portfolio that we are -- or have a good footprint in is in the automotive area, where we focus on automotive entertainment systems, keyless door entry systems and in vehicle networking. So I'd say those 2 portfolios represent clearly on the top of our revenue are coming good solid base of business and that we're really very excited about.

Question-and-Answer Session

Blayne Curtis - Barclays Capital, Research Division

Thanks. And this maybe a tough question. I think they're for the past, but as far as I'm going to ask everyone potentially the same question as far as the general business trends. You actually had one of the stronger guidance in the June quarter, you clearly have some specific drivers, I was wondering if you could maybe parse the 2 out and talk about what your sense as to just overall environment is this year. You're seeing some broader companies guide for pretty modest growth into June. You obviously got it up 9%. And then maybe if you could talk about the specific drivers that

Jeff Palmer

So we have 2 major segments of our business. We have our HPMS segment, which is about 72% of our revenue, very much company specific, very sticky design, win-oriented business. In that area, very much secular drivers, very much company-specific design wins. The other 30% of the business is the Standard Products business. Very much a cyclical business. One which is very much tied to that macro-environment. We see that general macro-environment is being kind of anemic, not great, not bad, it's not getting any worse. If you listened to our commentary on our Standard Products, you'll see that reflected in our comments there. I'd say that probably, we don't see Europe getting any worse right now? U.S. is improving. China is okay. But I don't think that we're off to the races and execution mass is up cycle like a lot of people talking about from the cyclical side of the business.

Blayne Curtis - Barclays Capital, Research Division

Right. Maybe -- I think one area that people are most hopeful of, in the second half of the year is in the networking end market. And you did see an uptick in that portion of your business? Are you seeing any indications that, that part is less "anemic" into the second half?

Jeff Palmer

No, the Infrastructure business is a great business for us. But our visibility into that supply chain is pretty poor. 50% of the time will be wrong and how the markets going to go. I know there's been a big excitement about our huge CapEx refresh in the second half off through China mobile. We're well-positioned. If it does turn out to happen, we'll participate. But quite honestly, our guidance for Q2 is only slightly better than normal seasonality. Part of that has to do -- we added a new customer into the mix. On a historical basis, our basic customers have been Huawei, ZTE, Nokia, Siemens networks, and then Q4 of last year, we started to shift new design with the Ericsson. So that kind of helped in normal seasonality. In other parts of that Infrastructure business, we have some new designs that we're also launching not for base stations but for some mobile audio products we have. So that's kind of giving us slightly better than seasonal but I think given that the visibility into the market is so tough, we'll stick with our 90-day commentary and leave it at that.

Blayne Curtis - Barclays Capital, Research Division

Right. The focus early on, as far as the different product cycles was NFC and I think you've got a little overdone in that business. I had seen some competition move in. And I think it's less of the focus these days. But the one area I get questions a lot is the core ID business and that's actually probably a better grower even this year for you but a hard one to quantify. I was wondering if you could -- how do you look at that opportunity the relative competitive position and the growth profile there?

Jeff Palmer

So we think the ID business is a double-digit growth for the next several years in aggregate. In the core ID, which is made up of egovernment, banking cards, automatic fare collection, infrastructure and tags the label, what's helping us drive growth right now has been contact with [indiscernible] in Asia. That started in the second half of last year and we'll continue through at least the first half of this year. It won't decline in the second half but it will moderately kind of slight out a little bit as we kind of get over the initial hump of the launch. And then out into the '14 and '15 timeframe, we would anticipate kind of an EMV upgrade cycle here in the U.S. It's a tough business to quantify because it's not a units x ASP business like PCs or handsets. It's a project-oriented business. And it's a project-business that can be very, very lumpy at times. We have fairly decent visibility into projects we have coming down the pipe but the exact timing of when they'll actually launch is never, never perfect. In general, we think we're a market leader there. I think we have probably, at least 70% market share in most of the areas we participate. We are accelerating some R&D investment in ID to continue to expand our leadership, if you will. And we think it'd be a growth driver for at least the next several years.

Blayne Curtis - Barclays Capital, Research Division

One other area in ID is authentication. I think the first time I saw it but it's in the first inning, I think you have some quantifiable wins, other opportunities as well. Maybe you could talk about authentications as another part of that?

Jeff Palmer

Yes, yes, so authentication is really the concept of validating or controlling and protecting brand and validating, protecting things. And so what we've seen is we have an opportunity where we have a large kind of a software OEM with a large number of employees internally and they're looking at moving towards to kind of a device that looks almost like a USB device that would have a secure element or very diverse secure element in it. And an employee would come in the morning, plug that into their computer and it would decrypt all their passwords. So as opposed to, let's say, using their RSA token or something like that. If we're successful with this, this OEM may choose to launch it to their customers externally. The wouldn't be until 2014. There'll be doing an internal trial, the second half of this year. We've now put a dollar figure on it. But it's a very exciting area that we think could -- actually, authentication could be larger than mobile transactions over the long-term. We're also seeing OEMs like networking OEMs who are looking at trying to figure out how they protect their brand. Then as an example, you buy a high-end router. Chassis from one of the big OEMs. We pay a lot of money for it. And then you decide you might want to go out and buy a second market kind of a blade plug-in. We'll, if that blade brings your whole network down, who are you going to call? You're going to call the main OEM? Who's chassis it is? So we've seen some of these companies look at putting authentications solutions on the blades and in the chassis. So when you plug the blade in, the very first thing it does is it says, Is this a valid blade? before it even turns power on. So just those type of ideas. We've seen some liquor companies in Russia using our authentication products to authenticate that the product is up and tampered with, like in the tops pharmaceutical companies. So there's a whole host of different applications.

Blayne Curtis - Barclays Capital, Research Division

And what about it's far as NFC into handsets. You had one -- there's one big customer that has adopted it. You haven't really seen as that much as far as payments and I think you've seen other ways that you can do payments through barcodes and such and you're kind of, what's the overall just view of just NFC in handsets and do you -- do we actually ever get this payment or portion?

Jeff Palmer

I'm biased but I think we do. I think it's not an if, it's a when. And you kind of use your baseball analogy, I think we're probably, clearly in the first innings on mobile transactions. Last year, 2012, we think there was roughly 125 million, 150 million NFC-enabled handsets in the marketplace. We were supplier to a vast majority of those. We think the number of NFC-enabled handsets grows rapidly here in '13, '14 and '15. We still think that based on third-party research by 2015, 50% of all handsets would be NFC-enabled. I think the issue is not a technical challenge anymore. It's really a business challenge. How are people going to monetize that secure element. And you want to think that, that secured element in the phone is almost like a piece of real estate that you can monetize, you can rent out to run different applications on it. And I think right now, we're just going through a period where people are trying to figure out what the business model is. If you really want to see the future of payments in terms of mobility, go to Asia. And you can see in Asia, they've already got into where they're putting transportation applications on to their phone. They've got low payment, low dollar amount payments on the phone -- a wide variety of different applications running, I'd say you're not seeing here in the U.S. I think it's more of a business issue as opposed to a technical issue.

Blayne Curtis - Barclays Capital, Research Division

That's it. And you did mention that the consumer audio portion is actually is in your Infrastructure & Industrial, so and it's not big today but just maybe you can just talk about your approach to consumer products? They come with growth, they also come with short time cycles, margins. Where do you really differentiate yourselves? And what's the opportunity there in the long run?

Jeff Palmer

Well, I think today, we've had a relatively small footprint in mobility. We're probably taking $2 to $3 per handset in aggregate in terms of that averaging speeds out of the handset. We think that could go up to maybe at the very high-end $5 or $6 over the course of the next couple of years. The areas we're going to participate if you think about the handset kind of too dimensionally on one level, there the big SLCs. The Baseband, [indiscernible] process, the connectivity chip, the PAs. Things that are very much dominated by the large SEC [indiscernible] margins. That's not our area of participation. And there's kind of a second level in modern handsets which are more what I'll call, kind in the guts in the bowels of the handsets. Things like, different types of interfaces, different types of cabling standards, mobile transactions for one, sensor hubs. These are areas that won't come up for bid every year but if you win the design, you're kind of in the architecture of the phone for a number of generations. And that's really where we're going to participate. Things would leverage our IP, leverage our mixed signal capability, leverage our microcontroller capability. You won't see us announce Bluetooth connectivity chip or anything like that well you've got to a Broadcomm and Qualcomm calm --

Blayne Curtis - Barclays Capital, Research Division

You just actually mentioned that -- I mean, in the -- sensor hub is one that people focus on as far as a driver and in Portable & Computing. You actually showed a good growth in June in that segment. Maybe you can talk about the near-term drivers there? And as far as I think the sensor hub is still on track for second half so you probably can't talk much about that one?

Jeff Palmer

No so maybe a little history would be good. In 2012, we started to ship several designs into one of the major handset OEMs. One of them was a interface aggregation device where the OEM had multiple interfaces that they wanted to put all in one chip and we were able to be competed very hard against several larger OEMs and we were successful. And we started to shift that in Q2. We're fully ramped on that in Q3 of last year. In Q3, we started to ship a logic device into kind of an active cabling solution that's fully ramped as of Q4. Those 2 designs are kind of already in the revenues' stack and with even flow with the seasonality of that customer. Late Q2 this year, we'll start to ship the sensor hub. We've pretty immaterial to revenues in q2. We think it should ramp pretty rapidly in Q3 and beyond. And so by the end of this year, we should have these 3 major kind of mobility design wins up into the revenue stack and then it'll come with flow in the with the seasonality and success of that customer. Currently today, most of those designs are with one OEM. Our focus is to be successful with the majors first before we go off and try to win other opportunities with other OEMs.

Blayne Curtis - Barclays Capital, Research Division

We've talked about all the good areas of their last earnings call. I think the one source power is the growth margin. I think maybe if you can talk about; the real cost was in the products with SmartGen and that was down 100 [ph] basis points and can you maybe talk about what happened? Why was it -- why was it -- why did it come out late, that this would be happening? And how do you fix it? And when is it going to come back?

Jeff Palmer

Yes. So it's a great question. We might won't get right through it. So in Q1, we had a shortfall of about $18 million dollars in our Standard Products business. About half of that was self-inflicted internally and about how of it was external market issues. If we look at the external issues first, we saw that $3 million worse than expected ASP pressure. So entering the quarter we thought negotiations will go one way, it was about $3 million worse than we thought. About $6 million was also due to mix. And the way you think of the mix is more as a substitution effect, we entered the quarter thinking 2 end markets were going to be stronger than they were. 1 PCs and we were expecting huge worth in PCs but better than it was. The second area was touchscreen, ESD protection for touchscreen phones. Most of these areas were slightly weaker than we thought. They do carry good margin, so when you do see some weakness there, it does impact the margins. The double-edge sword of Standard Products is you are able to go out in the market and do take transaction of the business. So the team and might have -- maybe a lot of sense at that time went into the market, took some transactional business to fill the revenue hole, if you will. But it was in a slightly lower gross margin. We think those 2 end markets' touchscreen, phones and PCs should come back and be seasonally stronger in the second half. So it was not designed loss at all. We'd assume that $6 million headwind in Q1 should come back within the second half. Now to the self-inflicted problem. And maybe a little bit more embarrassing. So the way to kind of discuss this is, we had 2 major back-end facilities in Asia. One in Southeast Asia and one in China. These facilities are highly automated paper[ph] factories. The way you get efficiencies out of these factories is to run to a very [indiscernible] are run very, very high throughput and you're running very, very tight specs. In Q4, the factory in Southeast Asia started to go out a speck a little bit. We didn't catch it immediately. We did end up having to recall some products, have to destroy some product but we thought it was relatively localized in Q4. What we didn't realize and this is maybe the more embarrassing part is in -- the quality team on the ground, how they got it under control is they reduced the throughput at the factory. Think about literally like slowing down the factory. And they put on a very tight outbound screen on testing that. It makes a lot of sense technically and logically. The challenge was we have the executive staff, did not learn that this is how they implemented to fix until very late in the quarter. And that at that point, there's really not much we could do about it. Now the in -- hindsight, it was the right decision. We feel they know how to fix the problem. We think to avoid any further embarrassment, we're assuming no improvement in Q2 but we think as we get into Q3 and we print Q3 results, the quality issue will be few fully washed out. So if you think about that $18 million as a headwind in Q1, I would say roughly $15 million should come back to us in the second half of the year?

Blayne Curtis - Barclays Capital, Research Division

That's great. And maybe just to refresh my memories as far the way you account you the inventory. You take the charge in the quarter or you have to wait for this product and get the yields back up and then sell-through before you get the benefits.

Jeff Palmer

So we do take a charge in Q4 on the product that we without a spec and we ground up. In terms of, let's say, the low utilization, that should wash itself through during in Q3. Because the very high volume, high turnover factor. We build roughly 70 billion units a year from this factory and so it's not a lot of inventory but we do have to kind of run-through the product in Q2.

Blayne Curtis - Barclays Capital, Research Division

And then a maybe harder question to ask but as far as the view to go in the open market and I think Peter talked about pricing pressure on the conference call and it wasn't necessarily that I guess, so it's more open market pricing. Is there -- you should have some volumes improve and you would need to but is there was a kind of rational for actually going in the marketing versus taking a lower revenue level?

Jeff Palmer

Yes, we run the business as we allow the GMs to run the business is fairly autonomously. And the gentleman, he's ran the Standard Products business good operator for long period of time. And it was a decision he made. If I'd made logical sense to him to at least deliver on the top line. The way you want to think about the Standard Products business is that a bit of a continuum. At one end, it is purely silicon by the pound, very little differentiation. There's always a buyer at a price. At the other end of the spectrum, it's actually very sticky. Automotive Standard Products you actually have to win designs. ESP protection, you actually have to win design. So in a[indiscernible] market, when things are clearly in an upcycle , you can kind of go in to the marketplace and craft your margin profile based on what type of business you want to take. If you look back of our results in 2010 and 2011, it was clearly a seller's market. Clearly this business has ran on the high 30% gross margin, very nice robust 20% plus operating margin. I'd say, in 2012, we kind of I mean, the outlook and become more of a buyer's market. And you don't have the freedom to pick and choose where you want to be. And then the decision to go into the market and take some opportunistic business and you can follow up that guy but I guess I wasn't in the shoes in hindsight is 2020

Blayne Curtis - Barclays Capital, Research Division

I'm a finance guy, so....

Unknown Attendee

Organization and how you think about what do you think about on operating dollars for as for selling stuff marketplace by the margin.[indiscernible]

Jeff Palmer

So the question that was asked is how do we look at what's is -- what's the trade-off between an incremental dollar revenue versus what's an incremental dollar of profit? I mean, that's another way to say it. I think we allow the general managers to run their businesses fairly autonomously. We don't have a dictate that says, "you must deliver x." We have goals that said that each division should run an EBIT target EBIT target such as they're not alluded to the overall company. But we don't micromanage the guys.

Blayne Curtis - Barclays Capital, Research Division

Other negative further impacts from them taking that business. it doesn't seem as such, right? So if -- from a just the -- I mean, from a public market perspective obviously people fixate on margins from cash flow to the company, to the action he take drive more cash flow to the company to take very more cash for the company ...

Jeff Palmer

Incrementally, yes.

Blayne Curtis - Barclays Capital, Research Division

Maybe just following up on sensor products. You probably get this question a lot as far as the strategic fit of that business with your overall business that would -- but are you it does that there's some scale that it helps with these cross businesses also have fluctuations in design cycles, this is more standards hands maybe a little more stable and more standard maybe a little bit more stable. I think people want to know if this is a down business or a fine business or on up business? And then is their any synergies between the two, other than just giving you scale.

Jeff Palmer

Yes, so let's kind of hit it right on, the business isn't secular impacted. Well, it has had some challenges as of late -- it is not a secularly impacted business, we think we can fix this business even in a buyer's market, not a seller's market, it can still run in a high-teens operating margins. We have some more to do, we think we can get there. . We've been very clear since we've been public while Standard products is a good business. It's a good cash flow business for us, it's not strategic. It's not core to us. What it does provide and we have to balance is, it does give a scale. So scale in terms of with sensor products we're the #2 products vendor in worldwide distribution after TI. And so it's very nice to give the distributors a product that can sell and make some of those margins on and you can motivate them to help sell your most sticky rates HMPS product. So that's a positive.

It does gives us the ability to get good pricing from our back-end suppliers. Well they don't share back-end, we buy a lot of raw materials from the same people. Right? So it gives us -- we build 70 billion units a year. So gives us the ability to get good pricing. And then what the other thing does is since we allocate our costs company across the company, Standard products does cover a certain amount of our unallocated costs. So my, salary, Luke's salary and things like that. So you have to balance that off against what would the company look like if you didn't have it?

Blayne Curtis - Barclays Capital, Research Division

Right. I'll argue, you'll probably get a worst mouthful than even sensor product companies. So it's not like you have a growth multiple -- I think we're trying to fix that one.

Jeff Palmer

Yes, and I'll guess, I'll let the capital markets dictate what we're worth. I'm going to chime in on that one right now.

Blayne Curtis - Barclays Capital, Research Division

I think the other portion of the leverage story that is a positive was just a trainer-basis points that you have talked about, I think some people asked rolls that off-track now that you have this [indiscernible]products issue. You maybe talk about that Grainer [ph] basis points entail that you have been talking about for a while and kind of does that still apply?

Jeff Palmer

Yes, so the 300 basis points gross margin expansion is not off-track. We're still -- we still believe we can achieve that exiting this year. If we -- if you first time will allow me to assume that the Standard Products issue was a one-time event and you kind of assumed that it didn't have kind of baseline in. Well you can forget about it? But it makes it easier to try to give you a bridge. If we didn't have a Standard products issue, gross margins for the company would've been 47.5%, maybe almost 48% in Q1. We've said that kind of -- we assume we can get about a 300 basis point bridge to 50%. That bridge is really made up by 3 main things: One, improved pricing and volumes to the third-party foundry network, we're [indiscernible] to accelerate. That's about 1/3 of that 300 basis points. About 1/3 of it from IP monetization. we've been working for that the last 3 years. I'm really looking at how we can monetize our IP. We have fairly good visibility that by the fourth quarter, we can generate roughly $10 million a quarter in recurring revenue from IP licensing, it's about 100 basis points. And then the last 100 basis points comes from what I call block and tackling. Continuing moving from gold to copper interconnect improving some yield on some high-volume ID programs. Expecting a little bit of cyclical improvement on Standard products such as the utilization of tabs will get a little bit better. But no one big item. So we have multiple levers there to get to the 50%. Then we've also talked about lowering our OpEx. In Q4 of last year, we announced a reduction in force in our European operation, we're going to separate with about 700 to 800 employees, primarily on our SG&A organization. In Europe, it does take a little longer to separate from employees. So they don't begin to roll off the payrolls until Q3 and fully in Q4. And so that rift if you will, should resolve about a 200 basis point reduction in OpEx. Put that together with the gross margin expansion, should result in about 26% operating margin x base comp[ph].

Blayne Curtis - Barclays Capital, Research Division

Okay. And that's still -- I think you just said it, but given all the issues in your product that 26% applies this year?

Jeff Palmer

We believe so. I mean, if you -- going back to the discussion of what happened in Standard Products and how we believe it get fixed and when it get fixed, that by the time we get to Q3, this is a nonissue. And other issues for the margin expansion really have nothing to do with Standard price, other than a little bit of utilization improvement. The IP monetization will be in the HPMS side of the house. The way for pricing improvement, that's an HPMS side of the house. The Block and tackling, it's a little mix but not that significant.

Blayne Curtis - Barclays Capital, Research Division

You recently did a debt offering out of a pretty favorable price and I think Peter recently lowered the kind of interest expense guidance for this year to 185. If you talk about what's the mechanics to get to that 185? If you can talk as far as retiring that given the offering or...

Jeff Palmer

Yes, the 185 is a bit of a natural outcome of the deal that was done. We were very lucky in the marketplace over the last 2.5, 3 months. We have refinanced $1.75 billion of our secured floating rate debt and we put in place unsecured fixed rate debt. We have $1 billion that's at a 5.75% and the deal you just referred to is $715 million or 3.75%. That $715 million, we took the proceeds and we called a $616 million note that was about 6%. So the delta between the 3.75% and the 6% gives you an inherent improvement. The also -- what we're doing is going out and calling the floating rate notes that are due at the end of this year but $240 million at L+3 325. So you take those 2 -- there's 2 transactions along results in about to $10 million improvement in full year interest expense.

Blayne Curtis - Barclays Capital, Research Division

And I think obviously you'll end the year at a lower rate, which should benefit you next year. I think you've talked about getting that to $2 billion level. And if you talk about -- what's the kind of rationale for -- And I think the debt now seems in vogue, I think more and more coming, actually adding.

Jeff Palmer

Believe it or, the big change.

Blayne Curtis - Barclays Capital, Research Division

So I'm not being up I actually think it's the right move and I think more [indiscernible] should take more debt. But you just -- how you think about debt and in one maybe talk about the other kind of [indiscernible] areas at some point be past reducing debt, it's actually going to have $800 billion of cash flow intent. What do you do about that and what are your options?

Jeff Palmer

Yes, our view and kind of roadmap we're following is the short-term goal or intermediate-term goal is to get to 2x leverage ratio. So that's net debt to trailing 12 months adjusted EBITDA. Exiting Q4, we were 2.4x. So we believe we can hit that 2x leverage ratio, exiting Q4, maybe early Q1 next year. So we think that's within our grasp. As you mentioned, we're not afraid of leverage in the company. We are a little bit different than a lot of the semiconductors company This is new in-vogue view, this is the management team -- given the cyclicality of our industry, we believe a little bit of debt is appropriate. $3.5 billion of gross debt like we currently is a probably a little bit more than we'd like. Our long-term goal is to get that done to about $2 billion of gross debt. That will probably be the in issues of cash, it won't happen overnight. As you mentioned, your model spits out 800 million of free cash flow. Others have seen their $600 million granted, we are going to generate significant amount of free cash flow in the coming years. I'd say we've not made any decision on how or what to do with returning cash to shareholders. We don't have any inherent buyers. We don't prefer dividends over buybacks. I think what I really want to do is comes out as what is the best use of an incremental dollar of cash we would return to a shareholder. If the shares are trading the way they are today, which we believe our undervaluing you . You've said the same thing, right? It would say that buying shares back would make sense but we've not. But we've not stuck our stake in around one way or the other. We've given ourselves a bit of flexibility and I know the market doesn't like flexibility, they like certainty, but at this point, there's really no reason for us to ham ourselves in.

Blayne Curtis - Barclays Capital, Research Division

Right. There's a little time. I wanted to open up to any questions if not I'll keep going. But do we have anything?

Unknown Analyst

You mentioned the packaging issue in, I guess, Southeast Asia facility, and then you mentioned your other big facilities in China. And the Southeast Asian facility was with Standard Products. So where are the security products packaged, I wonder?

Jeff Palmer

They are packaged at a different facility. I believe outside -- I think, one is in Taiwan and one's on Mainland China. So it's completely different factories.

Unknown Analyst

In China.

Jeff Palmer

The packaging. Where I was really alluding to the different packaging, not the fabrication. So maybe just to your point [indiscernible] and also the Standard Products business has 2 major fab facilities, one in Hamburg, one in Manchester and 2 major back-end facilities, one in Changdale [ph] and one in Southeast Asia, they're very segmented just for that product line.

Blayne Curtis - Barclays Capital, Research Division

Well, we're talking so much about manufacturing? Maybe you could just talk about your utilization as far as where are they in that business? And what are you expects, I guess?

Jeff Palmer

So as of Q1, our total factory utilization was about 83%. But if you peel into that and look at the discrete factories, the Standard Products factories, the prices I mean in the 70%. The IC factories and HPMS factories are fully utilized. So really no incremental margin benefit as you traditionally think on that side of the house. In growth for us will come from leveraging assets [indiscernible] long-term. Currently, we're in the process of shutting 2 fabs down in Holland, 6-inch and a 4-inch factory. They will be closed at the end of this year, that will leave us with one 8-inch factory in Holland, in Nijmegen, and its sister factory, RJV with SSMC in Singapore. And then we'll leverage outside factories for growth.

Blayne Curtis - Barclays Capital, Research Division

And maybe another question. And it seems like you would have some big drivers for you in the HPMS business as far as gross margin. Obviously, that will be accretive to your gross margin for Standard Products, obviously, is there any mix consideration in as far as within HPMS? As far as that a mix perspective?

Jeff Palmer

You mean from a mix perspective?

Blayne Curtis - Barclays Capital, Research Division

Mix perspective for gross margin.

Jeff Palmer

I don't think -- as I think that there might be a little bit of mixed headwind in the first half as we talked about on the call, contact with banking has been a big part of core ID's growth. Second half of '12 it will be a big component of growth here in the first half of '13. In the hierarchy of all ID products, contacts banking is a little less ideal. So positive relative to company. But in the less idea. So it's that's going up its sharp growth curve. It's going to be slightly diluted at tidying margins. But as we get into the back half of the year, we think [indiscernible]. I can't really identify any other mixed specific new design wins is going to come on and be dilutive, our new design wins is going to come on and be incrementally out of it and really shift things around. I think the real movement on gross margin are the items we discussed earlier.

Blayne Curtis - Barclays Capital, Research Division

And I just want to ask you, we didn't cover the auto segment. As far as that seems to be out for most people in the first quarter, it seems like it's tapered, assuming that there was some splashing correction as far as -- what's your sense of just the auto supply chain and I guess what's your exposure in Europe? I mean, it seems like Europe continues to struggle, U.S. is better, China seems better as far as you'll think that you're a European company. They assume that you're all Europe, maybe you could address some of those?

Jeff Palmer

Right, in terms of our -- we are a European company. We are domiciles in Holland. It is why you get a 10% long-term tax rate after [indiscernible] It is a benefit. But in terms of our market exposure, we shipped no more into Europe than any other semiconductor company. We have largely 20%, 25% revenue exposure as a total company. In terms of our Auto business, you have to remember how we actually go to market. So we ship our products to people, what I'll call intermediaries, people like Continental, Bosch, [indiscernible], These companies will package our products into modules and ship them to the OEMs factories and other places in the world. So I may ship a product to Continental in Europe. And I reflect that as European PLS. But that module might actually get shipped to BMW in South Carolina or Volkswagen in Brazil. I result track of it on a kind of a next leg. From a historical perspective, I mean, it's probably makes logical sense, we have a larger footprint with the Northern European automotive manufacturers. We have a very large footprint with the North American auto manufacturers; then thirdly, China, the JVs, as well as the indigenous Chinese manufacturers. Relatively underrepresented in Japan and I think that's something we might have fixed over time but it will take a long time.

Blayne Curtis - Barclays Capital, Research Division

In the same part of that, does just the supply chain help, I mean, it seems like there was a bit of a tailwind for people that has dated whichever sends that off in the market?

Jeff Palmer

Well, first off, I'd say, and I spent most of my career in semis, not in the auto business, more on the comp side of things. I'm not an expert on autos but what it is that I have learned is it the auto supply chain is not homogenous. Like the PC or the handset. We saw you on Q1 down, we had expected Q1 to be actually down, it's kind of low-single digits. Actually came in up a point so actually it's better in Q1. Our guidance for Q2 is kind of up single digit -- upper single digit,it's seasonal. It's really [indiscernible] but I know it's different -- I looked at one of our peers last night who reported and posted, 14x quarter-to-quarter growth and I was like, "wow." So it's definitely different for every OEM. In terms of the supply chain, I think it's also important to understand how we manage that business and say VMI model, our vendor management inventory so we can sign the inventory to the different build location. They -- the OEMs only pull the material as and when they need it. There's no motivation for them to pull, unless they're going to build a product. Okay?

Blayne Curtis - Barclays Capital, Research Division

There's maybe one time for one more question if they have it. If not, we'll leave it here. All right.

Jeff Palmer

Okay, great. Thank you very much, Blayne. I appreciate it. Thank you.

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