NXP Semiconductors NV Management Discusses Q2 2013 Results - Earnings Call Transcript

| About: NXP Semiconductors (NXPI)

NXP Semiconductors NV (NASDAQ:NXPI)

Q2 2013 Earnings Call

August 01, 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

Vivek Arya - BofA Merrill Lynch, Research Division

James Covello - Goldman Sachs Group Inc., Research Division

Mark Kelley - Barclays Capital, Research Division

Christopher Caso - Susquehanna Financial Group, LLLP, Research Division

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

Ross Seymore - Deutsche Bank AG, Research Division

Harlan Sur - JP Morgan Chase & Co, Research Division

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

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

Mark Lipacis - Jefferies LLC, Research Division

Operator

Good day, ladies and gentlemen, and welcome to the Second Quarter 2013 NXP Semiconductors Earnings Conference Call. My name is Sonia and I will be your coordinator today. I would now like to turn the presentation over to your host for today's call, Mr. Jeff Palmer, Vice President of Investor Relations. Please go ahead, sir.

Jeff Palmer

Thank you, Sonia, and good morning, everyone. Welcome to the NXP Semiconductors Second Quarter 2013 earnings call. With me on the call today is Rick Clemmer, NXP's President and CEO; and Peter Kelly, our CFO.

If you've not obtained a copy of our second quarter 2013 earnings press release, it can be found in our company website under the Investor Relations section at nxp.com.

Additionally, we have posted on our Investor Relations website a supplemental earnings summary presentation and a document of our historical financials to assist in your modeling efforts. This call is being recorded today, and will be available for replay from our corporate website. This call will include forward-looking statements that involve risks and uncertainties that could cause NXP's results to differ materially from management's current expectations. The risks and uncertainties include, but are not limited to, statements regarding the macroeconomic impact on the specific end markets in which we operate, the sale of new and existing products and our expectations for financial results for the third quarter of 2013. Please be reminded that NXP undertakes no obligation to revise or update publicly any forward-looking statement. For a disclosure on forward-looking statements, please refer to our press release.

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

Pursuant to Regulation G, NXP has provided reconciliations of the non-GAAP financial measures to the most directly comparable GAAP measures in our second quarter 2013 press release, which will be furnished to the SEC on Form 6-K and is available on NXP's website in the Investor Relations section at nxp.com.

Before we begin the call, I'd like to highlight our attendance at the following upcoming investor conferences during the third quarter. We'll be at the Jeffries 2013 Corporate Assets Summit on August 28 in Chicago. We'll be attending the Deutsche Bank 2013 CMT conference on September 10 in Las Vegas. Now I'd like to turn the conference call over to Rick.

Richard L. Clemmer

Thanks, Jeff, and welcome, everyone to our NXP earnings call today. We are very pleased with our performance in Q2, which came in at the higher end of our guidance, both on revenue and on earnings. More importantly, we are also encouraged that the broad-based momentum we experienced in Q2 should continue into Q3.

Our result in our guidance are clear proof points of the diversity of our product portfolio and that the design win momentum we have discussed in the past is coming to fruition. We believe our results are a reflection of the success NXP has achieved in delivering value-added products to our customers across multiple end markets.

I'd now like to move on to the results for Q2. We delivered product revenue of $1.16 billion, a 10% sequential increase and a 12% increase from the comparable year-ago period. This was in the upper range of our guidance. Total NXP revenue in Q2 was $1.19 billion, just over a 9% sequential increase and nearly a 9% increase from the comparable year-ago period.

On a segment basis, total HPMS revenue was $878 million, up 13% sequentially and up 18% versus the year-ago period. That was $15 million better than our expectations. Our HPMS segment delivered excellent results, as we experienced robust double-digit sequential growth across all of our focus end markets. I would also like to highlight that our Identification and Automotive HPMS businesses achieved record revenue levels during Q2, and both are now each solidly operating in revenue run rates of over $1 billion per year. I'd like to thank both teams for their intense customer focus and passion to win to achieve the targeted goals.

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

Our core ID business was up 28% sequentially, representing over 80% of overall IV revenue. This is a new record revenue, and was above our expectations due to the combination of better than anticipated demand for contactless banking products, as well as very good demand for automatic fare collection and Infrastructure products, which are areas we don't talk about much.

Design momentum for our core ID products continues to be very strong across all verticals. Our emerging ID business declined in the quarter with lower mobile transaction revenue. We expect that our mobile transaction business will be roughly flat year-on-year due to the effect of already well-documented product transition at one of our major customers. And the adoption rate of the new design wins continues to be truly outstanding. We continue to see encouraging volumes of new design wins at all of our customers, with over 300 SKUs currently having been awarded, with a clear shift to our next-generation NXP and secure element technology that will bring about an even better consumer experience and more enhanced security.

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

Turning to our Automotive business. Revenue was $253 million, up 10% sequentially and up 4% versus the year-ago period. That was above guidance. The business delivered strong sequential growth due to the combination of better than seasonal demand, the launch of a new customer entertainment programs and the continued ramp of major keyless door entry programs.

And now turning our Industrial and Infrastructure business. Revenue was $180 million, up 18% sequentially, and up 15% versus the year-ago period. Performance in the period was very good across the entire portfolio, with all product lines contributing to the growth.

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

We believe the long anticipated 4G buildout in China is still ahead of us, beginning in the second half of the year, which should help support even further growth. Our P&L -- our Power and Lighting business was up over 20% in the quarter, though from a small base, but still very good growth. We continue to maintain our leadership position in silicon tuners with the business up in the high single-digit range during the quarter.

Within our Portable & Computing business, revenue was $106 million, up 14% sequentially, but down 1% versus the same period a year ago. Our High-Speed Interface and Microcontroller business were both up in the low teens percentage range on a sequential basis. Growth during the quarter was primarily a result of the rebound in our broad-based, nonmobile business.

Consistent with our expectations, the initial shipments of the new sensor hub microcontroller design wins began as expected. We also experienced a modest rebound in demand for existing mobile interface designs of the Tier 1 mobile OEM. Our traction with new and existing design wins in the smartphone space is doing very well.

Turning to the Standard Products segment, revenue was $281 million, up 1% sequentially and down 3% versus the same period a year ago. Our performance was slightly below our expectations as a result of weaker than projected sales for certain logic products within the mobile end market. The revenue performance of our discreet business, which is -- had some issues over the last couple of quarters, had incrementally improved and was up during Q2. As we've said in the past, the top line performance of our Standard Product segment is a good first order approximation of the direct influence of the macroeconomic and external cyclical patterns on our business.

Moving on to the distribution channel performance. Absolute inventory dollars in distribution was flat versus the prior quarter. On a dollar basis, sales into distribution were essentially in line with sales out. The total month of supply within our distribution channel declined to 2.2 months, below our longer-term metric of around 2.4 to 2.6 months. We see this as low for the level of future business we anticipate, and are working with our distribution partners to improve inventory levels.

In summary, our performance in Q2 was very good. Our HPMS segment is firing on all cylinders. Our model of strong franchises across multiple end markets is enabling us to perform exceptionally well, even if certain high-profile markets like PC and high-end smartphones experienced moderating growth.

The product line teams have worked diligently on overall 26% operating margin performance target and to execute on the operating expense control programs, while yet still investing in R&D for future drivers of growth. The HPMS segment is now performing solidity above 27% within the operating margin model we had targeted. The Standard Product segment is slowly beginning to recover, and we have confidence of its return to expected performance levels. We are very confident in achieving our overall company margin targets, as Peter will highlight in a moment. Taken together, our performance translates into top line growth, better than industry peers, very good and improving operating profitability and stellar bottom line earnings growth. We believe our model will continue to deliver superior earnings growth. Now I'd like to turn the call over to Peter to review the financials in more detail. Peter?

Peter Kelly

Thank you, Rick. Good morning to everyone on today's call. Overall, we delivered a very good quarter. The main highlights being stronger-than-expected top line revenue growth, stronger-than-expected non-GAAP earnings, the continued pay down of our debt, as well as completing a debt transaction, which converted about $750 million of floating rate secure debt to fixed-rate unsecured debt, with a very attractive interest rate.

Moving on to the specifics of the quarter, top line revenue was $1.188 billion, up 9.5% versus the first quarter, and above the midpoint of our guidance. We generated $540 million in non-GAAP gross profit, or 45.5% non-GAAP gross margin. This is about $46 million better sequentially when removing the one-time legal benefit we recorded in our first quarter results.

Total operating expense was $285 million or 24% of revenue, an improvement of over 200 basis points versus the first quarter. During the quarter, we made excellent progress on the expense control programs we've previously highlighted, and we are clearly demonstrating the operating leverage in our model. We continue to invest in R&D. And although we stepped up our R&D investment, we were not able to rate it quite as much as originally planned. All in all, this resulted in non-GAAP operating profit of $256 million or 21.5%, about 50 basis points better than our guidance, and 200 basis points versus the first quarter. Again, normalizing for the one-time benefit realized in Q1.

Let me now turn to the segment performance. Within our HPMS segment, revenue was $878 million or 13% versus the prior period, and approximately $15 million better than expected. HPMS non-GAAP gross profit was $472 million or 53.8%, and non-GAAP operating profit was $238 million or 27.1%.

In our Standard Products segment, which to remind you, is now the combination of our General Purpose Logic and Discreet business, revenue was $281 million, up 1% sequentially and approximately $9 million below our target. Standard Product segment non-GAAP gross profit was $67 million or 23.8%, and non-GAAP operating profit was $26 million or 9.3%. The internal manufacturing issues we discussed on the last earnings call are largely resolved, and should have minimal impact in the second half of the year.

Interest expense was $47 million, slightly better-than-expected, non-controlling interest was $18 million, about $1 million above the guidance and cash taxes were $9 million or about $3 million better than expected.

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

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

Now I'd like to turn to the changes in our cash and debt. Our total debt at the end of the second quarter was $3.38 billion, down $59 million from the first quarter. During the quarter, we completed a $750 million unsecured note transaction and we used the net proceeds and cash on hand to repay both our $616 million 2016 secured floating rate term loan and our $243 million 2013 floating rate notes.

The new bond carries a fixed interest rate of 3.75%, and is due in 2018. We've continued to see interest expense in the $185 million range this year, and are committed to our ongoing deleveraging programs.

Cash at the end of the quarter was $569 million, down $26 million sequentially. And we exited the quarter with net debt of $2.8 billion, and a trailing 12-month adjusted EBITDA of approximately $1.2 billion, resulting in a net debt to trailing 12-month adjusted EBITDA leverage ratio of 2.3x.

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

You will note we bought back 1.7 million shares at a cost of approximately $48 million or just over $28 per share during the quarter. Additionally, yesterday, a new 10 million share repurchase program was authorized. Consistent with our prior program, our repurchase efforts are primarily aimed at offsetting the dilution related to employee option exercises.

Turning to working capital metrics, days of inventory were 104, a decrease of 7 days, and excluding the 3 deals for the restructuring of our fabs in Europe, is 93 days. Receivables days was 38, down 1 day, while payable days was 73, down 5 days, resulting in a cash conversion cycle of 69 days, a 3-day improvement from the prior quarter.

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

Now, I'd like to provide our outlook for the third quarter. Influencing our outlook again this quarter is strong demand due to company-specific design wins in multiple areas of our HPMS business. We currently anticipate product revenue to be in a range of up 4% to up 8% sequentially. At the midpoint of this range of 6% sequentially, we anticipate the following trends, all on a percentage point basis.

Within our HPMS segment, we expect Identification revenues to be down low mid single digits. Within our Auto business, we expect revenue to be flat, so relatively strong, given normal seasonality. Within Infrastructure & Industrial, we expect revenue to be up in the low teens range, and we anticipate our Portable & Computing business to be up in the upper 20% range, as new mobile programs begin to ramp in earnest.

Within our Standard Products segment, we anticipate mid single-digit sequential growth. We anticipate the combination of Manufacturing and Corporate and Other to be around $34 million. Taken together, total NXP revenue should be in a range of approximately $1.23 billion to $1.29 billion, or $1.26 billion at the midpoint, up about 6% sequentially. We expect non-GAAP gross profit to be about 46 at the midpoint, and we expect operating expenses to be about flat at 24% of revenue, though up in dollar terms, as we continue to invest in R&D and sales programs to support our ongoing and planned growth.

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

Interest expense on our debt should be approximately $44 million, cash taxes roughly $7 million and non-controlling interest expense should be about $16 million. Stock-based compensation should be about $20 million, which is excluded from our guidance. Diluted share count should be about 258 million shares, depending on share price fluctuations. Taken together, this translates into non-GAAP earnings per share in a range of $0.78 to $0.86, or $0.82 per share at the midpoint of our guidance.

Our 1/3 of housekeeping item in July, the Board of Directors of SMC, our joint venture wafer fab with TSMC, approved and distributed a special dividend in the amount of approximately $120 million. That is normal at this time of year. As a reminder, the joint venture is owned 62.5% by NXP, and 37.5% by TSMC, with the financials consolidating into NXP. The net result is our total cash balance has been reduced by approximately $46.5 million, to be cited in the third quarter.

Finally, and before I move to my summary, I'd like to provide an update on our stated margin expansion programs. At this point in time, we're on track with both our margin improvement programs and our OpEx improvement plan. We are confident that in Q4, we will achieve our goal of exiting 2013 at 26% non-GAAP operating margin.

In summary, a strong set of second quarter results, coupled with a strong outlook for the third quarter. Our revenue growth is clearly in excess of the market and is broad-based. We continue to generate significant cash and pay down debt, and will reach our debt to EBITDA target ahead of our plan by the end of 2013. Our earnings continue to improve, and the leverage in our model is being demonstrated with a 6% planned growth in revenue for the third quarter, driving a 16% growth in net income. With that, I'd now would like to turn it back to the operator and ask for your questions.

Question-and-Answer Session

Operator

[Operator Instructions] The first question comes from the line of John Pitzer.

John W. Pitzer - Crédit Suisse AG, Research Division

Wanted to ask a couple of questions around the margin profile for June, September and the full year reiteration. Just relative to the June quarter, it looks like you were slightly light of your guidance by our math, all due to Standard Products, so Peter, I'm kind of curious why you think Standard Products is now at a bottom and is going to improve from here? And specifically, relative to the forward September guide on gross margin, what's the expectation for standard product gross margin next quarter? And quite frankly, HPMS, given that a lot of the growth is coming from P&C, which tends to be lower gross margin, but op margin neutral?

Peter Kelly

I guess, a couple of things, John, you're right, in the quarter, we were a little bit lower than we expected at the gross margin level on the Standard Products segment. And it was, I think in Rick's notes, he mentioned that we were a little bit light on GPL revenue, which related to small phone and tablets. And that does tend to be a bit higher margin. So that's really what hits us for Q2. We really don't plan to guide our HPMS and Standard Products gross margin percent. But I think if you look back to kind of historic levels, there's no reason why a return to what we'd expect in Standard Products shouldn't drive probably 150 basis points improvement at the total NXP level on its own. You had a third question embedded in this one, or?

John W. Pitzer - Crédit Suisse AG, Research Division

It was the idea of P&C driving a lot of the growth sequentially in the September quarter, tends to be lower margin business. Is that all offset by the strength in INI?

Richard L. Clemmer

It's a combination of things, John. So I think it's safe to say that we feel comfortable about the guidance for Q3, with the combination of P&C and INI. I think it's also important to point out that some operational issues we talked about over the last couple of quarters in GA, we have seen improvement. The actual financial improvement results is delayed a quarter, as you know, from our PII implication. So it doesn't actually show up in the bottom line results in the quarter as that performance improvement takes place.

John W. Pitzer - Crédit Suisse AG, Research Division

Perfect, guys, and this is my follow up. Peter, glad to hear you reiterate exiting the year at that 26% op margin target. It does imply a relatively healthy jump, Q3 to Q4, so I'm just curious, are there any sort of incremental OpEx cuts we get, Q3 to Q4, to help you achieve that target? Or why so confident in that target exiting the year?

Peter Kelly

Well, I think there's, kind of 2 sides of it, John, on gross margin, we highlighted the 3 general areas, we were working -- we're very, very confident in the way they are progressing. So I'm very comfortable with that. I do think Standard Products will recover. And you'll note, our gross margin guidance for the quarter is kind of 46% to 47% on the range. So I think a small pickup in Standard Products were delivering on the gross margin programs. And OpEx -- I'll be very honest, a lot depends on the mix. My assumption is, has been around 50% gross margin and 24% OpEx. If we were really dependent on the revenue mix, you could have a slightly weaker margin, maybe 49% and a bp, but if that happened, then OpEx would naturally be lower as well. But it's hard to say at this point. Q4 is still a long way away. But I'm quietly confident at that 26% there.

Operator

The next question comes from Vivek Arya.

Vivek Arya - BofA Merrill Lynch, Research Division

Good to see the strength in Infrastructure and Industrial. Rick, I'm wondering how should we think about it beyond Q3 on the one hand that is, expectations of all the China at the average, but on the other hand, comps are getting tougher after a strong Q2 and your guidance for Q3. So how is the level of visibility along some of these Infrastructure bids, and how much is the visibility into an inventory build, versus actual consumption?

Richard L. Clemmer

So we've been rather cautious in setting expectations specifically in our high-performance RF area, based on the ups and downs and the lack of predictability associated with those demands. What we see is that definitely some of the customers are beginning to prepare with some initial orders, to ensure that they can meet the requirements of the ramp up. But when that actually gets shipped is very inconsistent, to say the best, over a period of time. So we still plan that business fairly conservatively. And we're not counting on huge upticks immediately based on that. But based on the demand that we see from our customers, we feel comfortable associated with the outlook that we're talking about.

Vivek Arya - BofA Merrill Lynch, Research Division

Okay. And the other thing, just how should we think about seasonality, then, in Q4? Because you also have other, very strong growth in your P&C segment, ID is also seeing very strong growth. Last year also, you had a couple of very good quarter than somewhat more of a seasonal outlook in Q4. So how should we think about seasonality this year, as you look at all the demand drivers?

Jeff Palmer

Yes, Vivek, this is Jeff. As you know, our view of seasonality is, there's no real magic here. When you look at our backward looking revenue that we posted, we take a median value over the past 3 years. And if you look at INI in the last number of years, it's stronger in Q2 and in Q3, a little weaker in Q4, but not substantial. So I don't think if there's anything magical we can give you insight, in terms of seasonality on that.

Vivek Arya - BofA Merrill Lynch, Research Division

One last question, on -- just on Standard Product gross margin, I think you mentioned that a couple of the issues had been resolved and the main weakness right now was just on the GPL side. It's impacted some of the smartphone ramps. So other than the mix issue, is there anything else that we should be worried about, whether it's a pricing issue or any other issue that would prevent improvement in standard product gross margins?

Richard L. Clemmer

No, I don't think so. I think, we're seeing a little bit of the pricing kind of, like we did last year, in Standard Products, where we saw the -- per significant decline in Q1, and then a little more stabilization, we were a little bit gun shy about where we would see that this year, but I think we've seen some of that more stabilization in Q2 or at least starting by the middle of Q2, I would say. So no, I think that we feel pretty comfortable relative to the guidance that we've given out, associated with Standard Products.

Peter Kelly

There's one thing to remind you also, remember, in our business model, the effects of improved utilization are seen 1 quarter afterwards. So as you saw in our results, utilization did go up in Q2, which is primarily in the Standard Products area. The effects of that will flow through the P&L and we've seen in Q3 and beyond. So if the issues that we had in our manufacturing facility are largely behind us, and the utilization's improving, we feel very confident in Standard Products getting back to where it's operated in the past.

Richard L. Clemmer

And now, by the way, the performance associated is well above all the competitors in that space, and even the performance that we demonstrated with the weakness associated with it, still [indiscernible] that one of the best performing Standard Products business in the industry.

Operator

The next question comes from the line of James Covello.

James Covello - Goldman Sachs Group Inc., Research Division

I guess, first question, relative to the model that you've all laid out many times, the $5 billion in revenues, $4 in EPS, first, assuming there's no change to that model, and then second, we're at that revenue run rate now in the September quarter, the quarterly revenue run rate that would get us to the $5 billion, and we're at $0.82 in EPS, could you give us the bridge chart that would walk us from the $0.82 in EPS, to the dollar in EPS going forward?

Peter Kelly

Well I guess, first of all, I do believe we can get the $4 EPS. And the bridge is pretty simple, Jim, you just have to get to 26% EBIT.

James Covello - Goldman Sachs Group Inc., Research Division

Well, I mean, I guess, how much of it -- is it just all that? It doesn't have anything to do with interest expense? It's just all EBIT?

Peter Kelly

You come in here, you can work out the math, it's pretty straightforward. The key thing for us as a company, is generate 26% EBIT. We're already starting to throw out lots of cash, we'll throw out even more cash, interest rate -- interest costs come down pretty dramatically. And you get the full dollars pretty fast. So, I mean, of anything, can feel more confident now than I did last September.

James Covello - Goldman Sachs Group Inc., Research Division

That's great. And then from a follow-up perspective, and I've asked this question to you guys several times over the years, including at that analyst meeting where you originally laid out the model. Given the choice between faster revenue growth and lower gross margins, you've said in the past you would take any business, even if it were lower gross margins that was operating profit dollar accretive, does that continue to be the model, and therefore should people maybe worry a little bit less about your gross margins, and focus a little bit more on the operating profit?

Richard L. Clemmer

Absolutely. I mean, what we've talked about all along, is that we're trying to drive bottom-line EBIT result, that deliver cash below free cash flow for the business. And we've said that we have ups and takes on product mix, on gross margin, and really, the key focus should be driving the bottom line EBIT results, which is what we're focused on, and what we're driving associated with it. So looking at the OpEx and the gross margin, our indicators about how we're going to get to that, but the bottom line is, we're very focused on driving the 26% EBIT, and being able to continue to make progress associated with that. It will continue to generate the significant free cash flow that will generate, going forward, that will continue to pay down our debt and be very accretive on an earnings basis. When you look at the backward earnings since our IPO, we've had about a 56% compounded growth in earnings. And you look at the opportunity to continue to drive well above anybody else in the industry, forward earnings growth.

Peter Kelly

Yes, I remember our conversation well, Jim. And I think we have a choice between significant revenue growth in excess of what the market sees, and 26% EBIT. I'll take that every time, as opposed to 28%, 29%, 30% and very low revenue growth. So we think a high revenue growth business with 26% EBIT would just drive massive value to our shareholders.

Operator

The next question comes from Blaine Curtis.

Mark Kelley - Barclays Capital, Research Division

This is Mark Kelley on for Blaine. The first question I have is about your Authentication business, it sounds like maybe it's pushed out a little bit. So my question is, are you still expecting to get the same share or has something else changed, any color there would be helpful.

Richard L. Clemmer

Yes, so we're still very excited about our Authentication business. Like, any time you have a new business, it's fundamentally a new core technology. It takes, either it will be faster or slower than what you planned, relative to the ramp up associated with it. While we're really encouraged on some of the activities that we have going on in cybersecurity, some of the opportunities to provide a more secure solution in access to the cloud did -- would not require the -- are that would be much more powerful than the current password protection that we all use, and some of the opportunities for authentication on products, we still are just as encouraged about the opportunities there. And in fact, to see it as maybe even larger than we did 3 or 4 quarters ago. But the ramp up, specifically associated with some of those programs, is not quite as rapid as we had originally envisioned. But no real indication of anything. And in fact, we think the strength we have, the unique security expertise that we bring, is still well-positioned to be able to provide a secure access to the cloud. Authenticating your access to the cloud will be a major factor in cybersecurity protection.

Peter Kelly

And Mark -- just to reiterate Mark's question, no share loss, at least this is really just a slower take off of a new business for us.

Jeff Palmer

Exactly. Mark, do you have a follow-up?

Mark Kelley - Barclays Capital, Research Division

I do. I guess, in terms of inventory levels, by geography, are there any areas that you think are more lean than others, any color you guys have would be helpful.

Richard L. Clemmer

It turned out specifically, as it relates to the distribution channel?

Mark Kelley - Barclays Capital, Research Division

Yes.

Richard L. Clemmer

Yes, I think that, clearly in Asia, I think there's a little less inventory, it's obviously, different levels by each one of our distribution partners, and some less, and some more. But I think there's probably a lower level of inventory, more on the Asian side, than the rest of the world. And that's clearly one of the areas that we're trying to work with our distribution partners on getting to the appropriate level of inventory, to be able to support the decrease in future demand that we see growing up. And I should be very specific, probably, our revenue guidance at the midpoint doesn't have a lot of increase in distribution inventory reflected in that. Although it would have a little bit of an increase in the low level that we ran in the most recent quarters, the 2.2 months in the high end of the range of revenue.

Operator

The next question comes from Chris Caso.

Christopher Caso - Susquehanna Financial Group, LLLP, Research Division

Maybe just to start, just on order of clarification. As you look into the fourth quarter operating margin guidance, it does seem that, in getting to that number, it would suggest a good increase in gross margins. Is the right interpretation of that, as you said previously, there's a quarter lag between the increases in production and the impact on gross margins, is that the explanation for what we're likely to see in Q4?

Peter Kelly

No, what we talked about previously, Chris, is there's 3 big programs we're working on. One's related to our wafer pricing. I mean, not literally just pricing, but some costs associated with wafers and other parties associated with basic blocking and tackling, including gold to copper conversions and the like. And the third relates to our IP portfolio. Clearly, there is a benefit from Q3 to Q4 -- sorry, Q2 to Q3 on utilization. But I would not expect a significant benefit from Q3 to Q4 on utilization.

Christopher Caso - Susquehanna Financial Group, LLLP, Research Division

Okay, so it's mainly on the cost side and on the addition of IP revenue in the portfolio that benefits the gross margin in Q4?

Peter Kelly

Yes, exactly what we talked about previously.

Jeff Palmer

Keeping our OpEx under control, it's a target.

Christopher Caso - Susquehanna Financial Group, LLLP, Research Division

And just as a follow-up then, you talked about, you didn't have a significant inventory restocking at distribution in your third quarter guidance. But I guess, if the conditions continue, what sort of signals are you getting back from your distributors at this point? And I guess, at what point would the distributors be forced to put on a little additional inventory? And I guess, in conjunction with that, what sort of visibility do you have, as the inventory levels of your customers?

Peter Kelly

I guess, a couple of things. On distribution, I think one of the things with distribution, when you're growing as rapidly as we are, it's sometimes not easy to keep the channel to stop those the way you would like. So we would see some movements from quarter-to-quarter. I don't think we are seeing the, and maybe Rick would like to comment, I don't think we're really seeing the channel or end customers having too much or too little inventory at this point in time, it seems it's pretty balanced.

Richard L. Clemmer

No, I think that's a good point, I mean you got to remember that all of our Automotive customers basically is a vendor-managed inventory, which is owned slight [ph] for them, so as far as they're concerned, that's at a very reasonable level. As we look at supporting the smartphone and tablet customers, that's very hand to mouth, associated with it. I guess, the one area that we've been ramping, and was a significant ramp of our revenue in Q2 was specifically associated with the contact with banking to support China. There clearly -- better ramp of the pipeline associated with it. And at some point in time, we'll see that come to more of a normalized run rate associated with it. But that's the only area at all where I think there was really a huge supply chain, we're calling it, not replenishment, but establishment, and that kind of gets lost a little bit in the rounding, but it's a factor in the guidance that we set for our ID business, which is down slightly for Q3 on a sequential basis.

Operator

The next question comes from Steve, sorry, Steve Smigie.

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

Rick, I was wondering if you could talk a little bit about potential growth drivers as we look out to 2014 for the ID business? And specifically, wanted to inquire about say, the Banking Card business there, and the Transit business. For the Banking Card business, does it take a ramp in say, U.S., chip and PIN banking cards to make that business grow, or are there other things that are more likely to be the driver in 2014? And for the transit, are there the specific programs that you have sort to be getting indications on now, in order for that to get it sort of typical growth rates for next year?

Richard L. Clemmer

So I think our ID business, with the broad portfolio of applications, everything as you say from the transit side to the mobile wallets to the contactless banking to PIN chip for U.S. or North America with the implementation associated with it, and also, we continue to be very excited about the cybersecurity protection associated with it. We feel very confident in the growth of our ID business having double-digit growth. Specifically, the China banking, contactless banking, has been a real opportunity for us, and has driven a lot of our growth over the last couple of quarters, been a significant contributor to that growth. But we see that still growing. We see that still being a significant position, where we've really been able to facilitate that transition in that market, and play a key leadership role in driving that. And what we are seeing, is now more and more interest as we go to mobile payment for people to begin to look at adding MIFARE and fare collection on to mobile phones to be able to accomplish that. So again, that just provides additional opportunities associated with a ramp up with our unique proprietary leadership technology, that we do license to other people as well. So I think there's a multitude of platforms that will continue to give us the confidence in our growth in our ID business. And we look forward to continuing to see the double-digit growth, not only next year, but for the next few years. And you have a follow-up?

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

Yes, just to drill down on your answer there a little bit, so on the mobile wallet that you mentioned, with the MIFARE, is that mostly going to be come in the form of some sort of licensing, or you end up on a solution where you are included separately, even maybe from just a semiconductor solution? And then, specifically on handsets too, is it still seem likely to you that, that even if maybe your Radio business wasn't as strong for NFC that the secure element portion of that still looks like on its own, could ramp pretty nicely next year?

Richard L. Clemmer

Yes, so MIFARE could be in the form of licensing, it could be in the form of shipment, so it would be in the form of both, I think that the fact that there is excitement about the usage of smartphones is a key factor. So we could deliver that in either way. I think the key thing for us in the mobile wallet is, we had seen the integrative radio be pushed out in time. And with our next-generation of product, that we're just beginning to ship, we see increased performance associated with that, so that we see the potential for discrete solution to potentially have longer life than we would have anticipated a year or so ago. And with that, with the increased technology that we have in this next generation of products, bringing a better consumer use and improved levels of security, we think is really key associated with that. So even though the consolidation of the radio is ultimately going to take place in the connectivity chip, we see the opportunity for us to continue to play in the mobile wallet space in a significant fashion, as we go forward for the next year, 1.5 years. Certainly, the next 6 to 8 quarters.

Jeff Palmer

And Steve, I'm just going add to that, to Rick's comment, is if you look for proof points in Rick's prepared remarks, we talked about being awarded over 300 SKUs, which go across the handset and other consumer products. So I think, companies are looking at who has the best technology from a security perspective, what companies have the best radio performance, who has the best interoperability, and I think they're coming back to NXP and our design win momentum continues to reflect that.

Richard L. Clemmer

And this is all about the security side, and it's about the ability to deliver that bulletproof security and that's where we think we do the best.

Operator

The next question comes from Ross Seymore.

Ross Seymore - Deutsche Bank AG, Research Division

Just following on, on that ID side of things, clearly quite different performances between your core in emerging in the June quarter, as we kind of expected with what's going on the handset side. Any color you can provide on those subsegments within your down slightly guide for the third quarter? And really, what I'm trying to get at is, where is the base on the emerging side, where either the inventory correction and/or seasonality comes into play and normalizes?

Richard L. Clemmer

Well, I think as we set the guidance, it's a reflection of 2 things, #1, as I've talked about, the pipeline that we've been filling up significantly, in the China contact was thinking, at some point in time, we'll see that ease off a little bit, Ross, to go to a steady run-rate as we get that supply-chain really filled. But to be fair, there are some of individual government programs that had pushed out in time, and is reflected, as governments looking where they're spending their dollars, so we still see the same opportunity for electronic passports, electronic ID cards that it's may be pushed out a little bit in time. And that's reflected in our view as well. So I think it's a combination of all of those, that says, we're going to be slightly down in Q3 timeframe. But still, feel very comfortable with the double-digit growth for that business as we look forward, Ross.

Ross Seymore - Deutsche Bank AG, Research Division

And I guess as my follow-up, one for you Peter, you guys have done a great job on the balance sheet management, you're confident that you're going to exit this year at your 2x levered targets, versus that 1 85 interest expense that I think you guided to for the full year this year, any sort of at least directional help on what you would expect your priorities to be for 2014 on that same metric, please?

Peter Kelly

Well, I guess a couple of things. Obviously, guiding 44 for the next quarter, I would say 4x that number would be lower than 1 85. But the direction is definitely lower, Ross, with -- in the middle of looking at our 2014 forecast. So it's difficult to say at this point exactly how much lower. We have one big chunk of debt we're really interested in, the 9 3/4, but it's, the breakage cost on that is just so, so high, it doesn't make sense right now. I'm sure we'll go after that early in 2014 and that help us on the interest comp result.

Operator

The next question comes from Harlan Sur.

Harlan Sur - JP Morgan Chase & Co, Research Division

As you mentioned, another leg to the margin improvement was to be able to monetize the broad IP portfolio. I think your target is to generate about $10 million per quarter in recurring revenue starting in Q4. I know these negotiations can be tough. So how confident is the team around being able to note secure and close some of these licensing deals in or before the fourth quarter of this year, and then to drive that sustainable run rate on a go forward basis?

Richard L. Clemmer

Well, Harlan, as you and I both know, there's no guarantees associated with that, because that's up to a negotiation process associated with it. I think the fact is, is that we've been investing in this area, and driving this for an extended period of time. We have Wall Streets in place, taking place. So we are very optimistic about the ability to drive the income from the intellectual property side. But to be fair, things can happen with core systems, et cetera. But I think we have all of the actions laid out to be able to accomplish that, and we just have to be sure that we follow through, and we're able to execute within the boundaries of the core systems and the negotiations with the third parties to be able to support that, but we're very confident, associated with it.

Harlan Sur - JP Morgan Chase & Co, Research Division

And then, on the Automotive side, you mentioned the launch of a new entertainment-focused program with a new customer. Is this focused around your car radio, software-defined radio, Telematics product offerings? And how much proliferation are you getting with this new customer across their portfolio?

Richard L. Clemmer

So it's broad-based. I think it's as we've said before, we now are the technology provider of choice for 27 of the 28, near the high-end car radios associated with it. So I would say that our technology has really become the technology solution of choice in those mid and high end car radios. And this is really the ramp-up of 2 or 3 of those design wins that we had won, a couple of years ago, that we're seeing the shipments associated with moving forward. So we continue to make great progress in that area. But the position we have there is extremely solid, and we'll continue to grow our revenue. And it's one of the reasons that allowed us to become the #1 semiconductor supplier shipping into China in 2012, with the recent industry reports that came out.

Operator

The next question comes from Bill Stein.

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

I'm hoping to dig into the prioritization of cash use once you hit 2x net leverage. We had, perhaps some indication with the new buyback authorization. It would seem that buyback at around these levels would perhaps be more accretive than even taking out the 9 3/4, can you give us an update in that area of the business, please?

Peter Kelly

Well, I think, what we said is, once we get to 2x trailing 12-month EBITDA, we'll review our options and do whatever is best for our shareholders. I mean, clearly, we believe that the current stock price were significantly undervalued. So Rick might shoot me for saying this, but I think if we get to the end of the year and our stock price is still $33, my guess, is it would make a lot more sense for shareholders to buy back stock than continue paying down debt. But I think we need to get there first, and then decide what we do.

Richard L. Clemmer

Yes, I think it's very clear that we have our goal to be able to achieve the low 2x annualized EBITDA from a debt position. And then what we've said is, is we're going to do whatever we believe is in the best interest of our shareholders in driving additional shareholder value.

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

And then 1 follow-up if I can, again on the ID segment. I'm going to go there as well. I think there's been some pretty widely discussed growth opportunities in the U.S. for chip and PIN, relative to the EMV initiative. Do you still see that? What's perhaps, what's your visibility into demand driven by that initiative?

Richard L. Clemmer

We still have discussions, and are supporting that process. I know that the credit card companies had set specific metrics or they will raise the fees that they charge, if there's not the PIN and chip implementation. So I think the key factor that takes effect is, if you look at the implementation in Europe with the PIN chip, the fraud rates are in order of magnitude below what they are in the U.S., where there's just the magnetic strip associated with it. So I think there's going to be -- continue to be an effort, probably the most near term will be associated with Canada, but pretty rapidly followed by North America. So we continue to see an opportunity, that's out over the next few years, not the next few quarters, to be quite fair, associated with it. But it's still a strong growth opportunity associated with our ID business.

Operator

The next question comes from Vijay Rakesh.

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

Just a question on the 4Q guidance, you said operating margin expanding nicely by 400 bps. Do you expect to see that improvement come about 50-50 from gross margins and OpEx?

Peter Kelly

Well, I didn't say. And to be honest, I didn't really -- I'm not into guiding the fourth quarter. What I'm saying is that, we expect we'll deliver 26% EBIT. But I don't want to get into how much is revenue, how much is margin and how much is OpEx at this point in time, we normally only give you a 1 quarter view.

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

On the license side, I know you're expecting a pick up there, is that something you'll break out, going forward? And how does the pipeline there look, I mean, I should look at 24 game [indiscernible] expect to see, expect to add more guys on the licensing side?

Peter Kelly

We've not disclosed that. And I guess, we've not decided what we will do at this point.

Richard L. Clemmer

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

Jeff Palmer

So we will take one last caller, please.

Operator

The next question comes from Mark Lipacis.

Mark Lipacis - Jefferies LLC, Research Division

Most broad-based suppliers saw increase in days at their distributors, and I was wondering if you could help us reconcile while yours -- while you saw yours, sound like yours went down?

Peter Kelly

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

Richard L. Clemmer

I think [indiscernible] because our dollars were flat quarter-to-quarter, our reduction from 2.4 to 2.2 months of inventory was basically as a result of the numerator increasing. So they weren't able to put inventory in place at a sufficient run rate to be able to maintain inventory levels that we think would be appropriate.

Mark Lipacis - Jefferies LLC, Research Division

Fair enough, and could you talk about lead times to your customers, what they did during the quarter?

Richard L. Clemmer

So you know it's really mixed, to be fair. Because a lead time is, it's hard to have a blanket lead time associated with it, with lead times that vary across the board. I would say that we did see some areas where lead times edged up a little bit. But not anything that would be a significant material change.

Jeff Palmer

Thank you. Well, I think that will be the end of the call today. I'd like to pass it over to Rick in case there's any closing remarks you'd like to make, Rick?

Richard L. Clemmer

Yes. Thanks a lot for your interest. We're very pleased with the performance that we delivered in Q2. The ability to continue to drive double-digit growth in revenue and make good, solid bottom-line profits. And with our HPMS business now performing within our operating income model that we've established, it gives us the confidence and the ability to point to actual results to demonstrate the value of the strategy that we put in place. As we look forward, we continue to be very optimistic about continuing to drive significant EPS growth and outgrowing market from a top line revenue. So thanks a lot for your interest, and we appreciate your support.

Peter Kelly

Thank you very much, everyone.

Operator

Thank you for your participation in today's conference. This includes the presentation. You may now disconnect. Good day.

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