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NXP Semiconductors NV (NASDAQ:NXPI)

Q1 2014 Earnings Call

April 24, 2014 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 William Pitzer - Crédit Suisse AG, Research Division

Ross Seymore - Deutsche Bank AG, Research Division

Blayne Curtis - Barclays Capital, Research Division

Vivek Arya - BofA Merrill Lynch, Research Division

Craig Hettenbach - Morgan Stanley, Research Division

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

Gabriela Borges - Goldman Sachs Group Inc., Research Division

Christopher Caso - Susquehanna Financial Group, LLLP, Research Division

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

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

Christopher J. Muse - ISI Group Inc., Research Division

Ambrish Srivastava - BMO Capital Markets Canada

Liwen Zhang - Blaylock Robert Van, LLC, Research Division

Sujeeva De Silva - Topeka Capital Markets Inc., Research Division

Operator

Good day, ladies and gentlemen, and welcome to the Q1 2014 NXP Semiconductors NV Earnings Conference Call. My name is Sheryl, and I'll be your operator for today. [Operator Instructions] As a reminder, this call is being recorded for training (sic) [replay] purposes. And I'd like to hand over to Mr. Jeff Palmer, Vice President of Investor Relations. Please proceed, sir.

Jeff Palmer

Thank you, Sheryl, and good morning, everyone. Welcome to the NXP Semiconductors First Quarter 2014 Earnings Call. With me on the call today is Rick Clemmer, NXP's President and CEO; as well as Peter Kelly, our CFO. If you've not obtained a copy of our first quarter 2014 earnings press release, it can be found at our company website under the Investor Relations section at nxp.com. Additionally, we have posted on our Investor Relations website a supplemental earnings summary presentation and a document of our historical financials to assist in your modeling efforts. This call is being recorded 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 second quarter of 2014. Please be reminded that NXP undertakes no obligation to revise or update publicly any forward-looking statements. For a full disclosure on forward-looking statements, please refer to our press release.

Additionally, during our call today, we will make reference to certain non-GAAP financial measures, which exclude the impact of purchase price accounting, restructuring, stock-based compensation, impairment and other charges that are driven primarily by discrete events that management does not consider to be directly related to NXP's underlying core operating performance. Pursuant to Regulation G, NXP has provided reconciliations of the non-GAAP financial measures to the most directly comparable GAAP measures in our first quarter 2014 earnings press release, which will be furnished to the SEC on Form 6-K and is available on NXP's website in the Investor Relations section, also at nxp.com.

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

Richard L. Clemmer

Thanks, Jeff, and welcome, everyone, to our earnings call today. Overall, our results for the first quarter were very good, reflecting better revenue performance, strong cash flow generation and slightly higher operating expenses as we continue to invest for future growth. Product revenue was approximately $1.21 billion as -- a 4% decline sequentially, though up nearly 14% versus the prior year period. Nearly all of our business lines delivered revenue performance above our initial expectations, slightly better than typical seasonal performance. Total NXP revenue was approximately $1.25 billion, also a 4% sequential decline, although up nearly 15% from the year-ago period.

Turning now to our segment performance. HPMS revenue was $912 million, nearly a 5% sequential decline, but up nearly 18% from the year-ago period. We are very pleased with the strong year-on-year growth. Our results continue to support our view that the HPMS segment can consistently deliver growth in excess of our industry peer group.

Now I'd like to review the results for our various HPMS businesses. Within our ID business, revenue was $319 million, down 3% versus the prior quarter, about $5 million better than our expectations, and up 6% on a year-on-year basis. Order trends from the core ID business were better than our expectations, declining about 2% sequentially but up 23% versus the year-ago period. Sequential growth within core ID was driven by demand for infrastructure and the support associated with the enhanced buildout in eGovernment solutions, offset by anticipated sequential declines in the remaining product lines.

Overall, core ID continues to represent about 85% of the total ID revenue.

Within our emerging ID business, which includes mobile transactions and authentication, revenue was down 15% sequentially and down 43% versus the year-ago period. If you recall, our Q4 results included a strategic IP licensing agreement, making quarter-on-quarter comparison less meaningful. From a product perspective in emerging ID, we did see good sequential growth of mobile transaction solutions as a result of the new major smartphone platform launch.

Moving now to our Portable & Computing end market, revenue was $135 million, a 15% sequential decline but up 45% from the year-ago period. This was near the upper end of our expectations, primarily due to broad-based demand for interface products. Further, our results in the quarter reflected the normal seasonal influences of the key smartphone and tablet markets where we participate.

Within our Infrastructure & Industrial business, revenue was $182 million, down about 8% sequentially, while revenue was up about 19% versus the year-ago period. During the quarter, revenue was modestly below our original expectations, primarily as we continue to manage HPRF product demand issues for base station customers. The revenue trends during the quarter for the remainder of the Infrastructure & Industrial product lines were essentially in line with our expectations.

Within our Automotive business, revenue was $276 million, another strong quarter. Revenue was essentially flat quarter-on-quarter, generally in line with our expectations, and up 20% versus the first quarter of 2013. From a product perspective, we experienced strong sequential demand for both in-vehicle networking and sensor products during the quarter. Demand for the keyless entry products were essentially flat, and sales of infotainment products declined modestly in the quarter, but both were in line with the expectations.

Finally, turning to our Standard Products segment. Revenue was $295 million, essentially flat on a sequential basis but better than our normal seasonal trend. Performance was better than planned and up about 6% versus the year-ago period. We experienced better mix in the business, primarily driven by the discrete portion of the business, as we continue to focus on winning longer-term stickier opportunities. The key message on our Standard Products segment continues to be the improved profitability profile.

Turning now to our distribution channel performance. Total sales in the distribution were down about 7%, with sales out of distribution down 2%. The total months of inventory in the distribution channel were 2.5 months. Absolute dollars of inventory in the channel increased about 3% on a sequential basis.

In summary, our overall results in Q1 were very good, with better overall product revenue, better gross margin and strong cash flow. With Q1 being normally our seasonally weakest quarter in a year, we feel especially positive about the remainder of this year. We believe we can continue to monetize our company-specific opportunities, which should result in better-than-industry growth, continued improvement in profitability and robust cash flow generation.

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

Peter Kelly

Thank you, Rick. Good morning to everyone on today's call. As Rick has already covered the dramas of revenue, I'll move directly to the highlights of the quarter.

Overall, Q1 was a very good quarter and better than our expectations. Total revenue, non-GAAP gross profit, operating profit and net income were all better than the midpoint of our guidance, resulting in non-GAAP EPS of $0.98.

Focusing on the details of Q1. Revenue was $1.25 billion, $16 million above the midpoint of our guidance. We generated $617 million in non-GAAP gross profit or 49.5% non-GAAP gross margin, about $19 million above the midpoint of our guidance, essentially driven by 3 things: about 1/3 was the result of better revenue; about 1/3 was due to better product mix; and about 1/3 was due to the onetime positive benefit relating to a product-related insurance claim of $5 million from our past period. Note, the insurance benefits is reflected in our Corporate and Other segment.

Now let me turn to the operating segments. Within the HPMS segment, revenue was $912 million, down about 5% versus the previous quarter but about $6 million above guidance. HPMS non-GAAP gross margin was 56%, 50 basis points below the fourth quarter. And non-GAAP operating margin was 27.3% of revenue.

Within our Standard Products segment, revenue was $295 million, essentially flat sequentially but about $6 million above guidance. Segment non-GAAP gross margin of 33.2%, 190 basis point improvement versus the fourth quarter. And non-GAAP operating margin was 18%, a 170 basis point improvement, as the business continues to normalize into our expected operating range.

Total non-GAAP operating expenses were $317 million, up $4 million on a sequential basis and above the midpoint of our guidance range, as we continue to pull forward investments in a major R&D program to support future growth and, to a lesser degree, incentive compensation.

From a total operating profit perspective, non-GAAP operating profit was $301 million and represents a 24.2% operating margin, down about 90 basis points versus the prior quarter. Interest expense was $34 million. And during the quarter, we repriced our term loan due in 2017, which lowered our overall blended interest cost to 3.9%, a 40 basis point improvement from the prior quarter.

Noncontrolling interest was $14 million, $4 million better than guidance. And cash taxes were $4 million, also $4 million better than guidance. This resulted in total NXP non-GAAP earnings per share of $0.98, $0.08 better than the midpoint of our guidance and flat on a sequential basis. Relative to our earnings per share guidance, about 3% -- about $0.03 of the upside was due to higher revenue and better mix, partially offset by increased OpEx; $0.02 was due to the previously mentioned insurance claim; and the remainder was due to lower tax and noncontrolling interests. Stock-based compensation, which is not included in our non-GAAP earnings, was $28 million.

Now I'd like to turn to the changes in our cash and debt. Our total debt at the end of Q1 was $3.58 billion, an increase of $262 million, as we took short-term usage of our revolving credit facility to fund stock buybacks. Cash at the end of Q1 was $720 million, a sequential increase of $50 million. We exited the quarter with a trailing 12-month adjusted EBITDA of approximately $1.41 billion, and our ratio of net debt to trailing 12-month adjusted EBITDA at the end of Q1 was 2.02x.

We bought back 8.3 million shares at the cost of approximately $458 million or a weighted cost of about $54.91 per share.

Turning to our working capital metrics. I would like to point out that both our DSO and DPO increased by approximately 6 days and offset each other due to the difference between our regular monthly calendar and our reporting calendar, where March 31 is the first day of our second quarter. Days of inventory were 102 days, an increase of 6 days sequentially. And excluding prebuilds associated with the restructuring of our fabs[ph] in Europe, our effective days in inventory was 91 days. Days receivable were 41 days, while days payable were 71 -- 77, sorry. Taken together, our cash conversion cycle was 66 days versus the 61 days reported in the prior quarter.

Cash flow from operations was $273 million, and net CapEx was $50 million, resulting in positive free cash flow of $223 million or 18% free cash flow margin.

Now I'd like to provide our outlook for Q2. We continue to see very positive trends across our business and still expect to see the 2014 demand environment develop stronger than 2013. With this as a background, we currently anticipate product revenue will be in the range of up 4% to up 9% sequentially. At the midpoint, we expect product revenue to be up in Q2 about 7%, reflecting the following trends in the business, all on a sequential percentage basis.

Within our HPMS segment, we expect Automotive to be up about mid-single digits, Identification is expected to be up in the upper single-digit range, Portable & Computing is expected to be flat, Infrastructure & Industrial is expected to be up in the mid-teens range, Standard Products is expected to be up in the lower single-digit range. We anticipate revenue from the combination of manufacturing and Corporate Other -- Corporate and Other to be approximately $40 million. Taken together, total NXP revenue should be in the range of $1.3 billion to $1.35 billion, or $1.326 billion at the midpoint.

We expect non-GAAP gross profit to be in the range of about 47.8% to 48.6%, or about 48.2% at the midpoint. Operating expenses are expected to be in the range of $310 million to $319 million, or about $315 million at the midpoint. This translates into a non-GAAP operating profit in the range of $312 million to $337 million, or about 24.4% operating margin at the midpoint. Interest expense on our debt should be approximately $35 million. Cash taxes are expected be roughly $8 million, and noncontrolling interest expense should be about $17 million. Stock-based compensation should be about $35 million, which is excluded from our guidance. Diluted share count should be about 252 million shares, depending on share price fluctuations. Taken together, this translates into non-GAAP earnings per share in the range of $1 to $1.10, or $1.05 per share at the midpoint of our guidance.

I'd like to now turn it back to the operator for your questions.

Jeff Palmer

Operator, would you call [ph] for Q&A, please?

Question-and-Answer Session

Operator

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

John William Pitzer - Crédit Suisse AG, Research Division

Just real quick, last quarter, guys, relative to the full year for ID, you guys gave some pretty healthy growth rates. And given that you're giving decent sequential growth rate guidance for the June quarter, year-over-year is still suffering from difficult comparison from last year. And so I'm kind of curious, are you still confident in kind of the ID growth rate for the full year? And help us understand the back half drivers of that full year growth would be helpful.

Richard L. Clemmer

So, John, remember, when we talked about that, we said high teens over the intermediate term, not for the year basis itself, just to be clear associated with it. But you shouldn't take any backing off of our expectations in growth from that comment either. I just want to be clear associated with it. Clearly, in ID business, we have talked about that we expect, with some of the design wins that we've seen, a strong ramp-up of mobile payments in the second half of the year. And that's -- it gives us the confidence in the growth rate that we have. So the combined design wins that we have and the business that we see, we think, will be the significant contributing factor. If we go beyond this year, then, clearly, the continued ramp-up of -- well, in -- even in the second half this year, the ramp-up of banking in developing countries. But if we look out beyond this year, then, clearly, the ramp-up of EMV in the U.S. is a factor relative to growth in ID as well. But there's a combination of a number of different factors in ID, so it's not any single factor. The Infrastructure side, to be able to support the combination of EMV, as well as mobile payments, we expect to see a nice uptick associated with that as well. So our ID business has a multitude of different areas where we expect to see continued strong growth. In the mid to high teens over a multi--- in near-term basis -- intermediate term basis, sorry.

John William Pitzer - Crédit Suisse AG, Research Division

Helpful, Rick. And Peter, on the gross margin guidance for the June quarter, at the midpoint, you're guiding gross margin down sequentially on up revenue. Can you just help me understand a little bit better what's happening with mix Q-on-Q that's driving that dynamic?

Peter Kelly

Yes. To be honest, it is -- once you exclude that $5 million insurance payment and the increased revenue, it is mix. And we agonize because we know no one likes to hear that the answer is -- it's mix. And it's not in any one area, John, so I can't say it's a result of a massive increase in one product line. Probably, the best thing I can say is it's probably a higher mix of kind of volume products in Q2 across pretty much all of our businesses. I think the good thing is that even though gross margin looks a little weaker, you can see that the EBIT continues to improve.

John William Pitzer - Crédit Suisse AG, Research Division

Perfect. And then my last question, guys, just on the buyback, big step-up in the March quarter from what had been sort of a $160 million per quarter to what was north of $450 million in the March quarter. And, Peter, in your prepared comments, you talked about kind of funding that through some financing activities. I'm just kind of curious from here, how do I think about the buyback level? Broadly speaking, what kind of targets should we think about over a 4-quarter period?

Peter Kelly

Obviously, a lot depends on what the stock price is, John. But I'll -- I think as I've said on previous calls, I'll continue to use our available cash to buy back stock. That just seems to be the best use of our cash right now versus anything else we can see.

Richard L. Clemmer

Yes, if you look at -- over the 4-quarter period of time, most of the projections, we'll have about $1 billion. And as Peter has talked about, our top priority will be to continue to repurchase shares, John.

Operator

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

Ross Seymore - Deutsche Bank AG, Research Division

Talking about the OpEx side, it was a little high in the quarter, and then you're guiding it up again in the guide. I know you talked about front-end loading some major R&D projects. Is there any more color you can give on that? Is that something that is imminent timing-wise, where the revenue from those investments is going to come through? Or is it even something that you're front-end loading it now, and then therefore, some additional leverage or lack of R&D would be necessary in, say, the second half of this year or even 2015?

Richard L. Clemmer

So what we tried to say, John -- Ross, was that we were pulling it forward. So because of the agreement that we talked about in Q4, obviously, we have a requirement to increase our investment levels. And we're pulling that forward to be sure that we meet the customer requirements associated with it. So it would support the growth that we anticipate in the next few quarters coming out in revenue, but we have to make those investments now to be able to support that product development to drive that growth, Ross.

Ross Seymore - Deutsche Bank AG, Research Division

Great. And I guess as my follow-up on the ID side of things, you said it was a little bit lighter in the quarter, nothing too worrisome, and you're guiding it up going forward -- in the I&I side of things, excuse me. If you have that base station business, can you give us an update? I think back in Mobile World Congress, you were one of the few companies saying things look like they could be a little overheated. And even on today's call, you mentioned that you were doing some either demand or inventory management. Can you give us an update on double ordering, demand versus reality? Any sort of color on that front will be helpful, and then I'll go away.

Richard L. Clemmer

So, Ross, I think the only thing we can really say -- I mean, we can't say whether our customers are double or triple ordering. There's no real way to know that. We would say that the significant broad increases that we've seen across the board from all of our major customers are difficult for us to support because of the significant spike of the increase in demand, with the requirement to put additional capacity in place, taking a much longer period of time to be able to bring that out. So we clearly see a very strong demand across the board from all major customers. Part of that is from the design wins that we've been talking about over the last couple of years that we've won on the LTE. But part of that is just from the broad overall demand increase. And we are struggling to be able to meet our customer requirements associated with it. But it's not -- there's no way for us to know for sure whether there's double or triple ordering taking place. All we can do is interface with our customers and try to meet as much of their requirement as we can, although the significant ramp-up of the demand is extremely difficult for us to completely meet their requirements.

Ross Seymore - Deutsche Bank AG, Research Division

So I guess, when you said it was a little bit disappointing versus your original guide, it really wasn't a demand issue anymore so than it was... it's for matching your supply to whatever demand was there?

Richard L. Clemmer

Absolutely. No problem with demand at this point in time. We expect [ph] a little less demand right now, Ross.

Operator

The next question comes from the line of Blayne Curtis from Barclays.

Blayne Curtis - Barclays Capital, Research Division

On ID, when you look at the guidance, is that a factor of mobile or -- you had mentioned that you're seeing some infrastructure pickup. Are you seeing any better indications of core ID picking up in China? You had talked about the spring timeframe. Just wondering what your thoughts are at this point.

Richard L. Clemmer

Well, yes. We talked about -- the core ID business had very strong growth in Q1. And clearly, we see an improvement in the demand associated with the banking in China. So I think what we talked about, we are seeing, but I think what we'll -- what we expect is to have that kind of higher -- mid- to high-teen growth coming on more strongly in the second half of the year than in second quarter itself.

Peter Kelly

But we definitely saw a pickup in -- or we are seeing a pickup in Q2 in banking for China.

Blayne Curtis - Barclays Capital, Research Division

Got you. And then, Peter, you talked about, really, mix being the driver into June. Is that something that you potentially reverses in the back half or is this -- are some of these factors a factor of businesses that you'll see continuing to grow?

Peter Kelly

I mean, it's hard to say, really. I think we have this massive focus on our EBIT. And it's surprising our relatively small numbers can change the percentage on the gross margin percent. I think our focus really will be continuing to manage our mix in line with our volume growth and, at the same time, seeing what we can do from a cost down perspective to improve it further. But I guess we'll get to that at the end of Q2, when we guide for Q3, but we're very confident on our roadmap to get into a world-class EBIT percent.

Blayne Curtis - Barclays Capital, Research Division

Got you. And then just finally, on Auto, there's a lot of concern about inventories. Clearly, you're guiding that out nicely. If you can just talk about what you're seeing in terms of inventory levels and what are the drivers for you into June.

Richard L. Clemmer

Well, we'll see -- in June, we'll see -- we talked about the car infotainment, which is about half of Automotive, being a little weaker in Q1, as we had expected. And we will see that come back clearly in the Q2 timeframe. So I think that's probably the key area. We don't see any slowdown of demand from our customers. So even though there were some discussions -- I guess I haven't seen any recent discussions on inventory, although, clearly, back, I guess, 6 weeks ago, there were some concerns about North America Automotive inventory, but we did not see any reduction in the pull rates from our customers through that period of time and don't expect to see any through the Q2 timeframe, Blayne.

Jeff Palmer

At the same time, Blayne, we start seeing very good uptick in registrations in Europe. So trends in the European auto market have actually been generally positive.

Operator

The next question comes from Vivek Arya from Bank of America.

Vivek Arya - BofA Merrill Lynch, Research Division

I have a question on your Portable & Computing business. You've done extremely well with one large customer on the interface and the sensor hub products. I'm wondering how the success in selling more products to that customer or in broadening out on those kind of products to other customers. I'm just trying to get a sense of what the long-term growth opportunity is and the level of customer concentration in that division right now.

Richard L. Clemmer

So I think the only -- I mean, it's consistent with what we've said, we're trying to broaden that out to other customers, including the broad-based growth that's taking place in smartphones in China. So there's a lot of activity going on. We have some favorable feedback. In fact, in the mobile audio, we have a broad base of design wins on the high end of smartphones in China. So I think the only thing we can really say is we're continuing to work that. We continue to be optimistic about driving that into other key customers, but it won't be a significant contributor in 2014 revenue. The 2014 revenue, P&C being up year-over-year 45% kind of talks about the success we've had in that business. And we'll follow up more of the seasonal patterns associated with it, and we'd anticipate kind of a strong growth in the Q3 timeframe after Q2 being somewhat flat.

Jeff Palmer

I don't think we see any change in our success with our major customers for P&C products at this point.

Vivek Arya - BofA Merrill Lynch, Research Division

Got it. And then, Rick, on the mobile payment side, there has been a move towards this use of this host-card emulation or virtualizing the secure element. Do you think that poses any threat to your emerging ID or the NFC business in any way?

Richard L. Clemmer

We don't believe so. I mean, time will tell. Our belief is, is that the host-card emulation, actually, could accelerate the mobile wallet rollout, but it doesn't provide the inherent bulletproof security that a true secure element does. And so all it takes is, a situation like Target had, for there to be a massive move from a host-card emulation to a secure element implementations to be sure that the inherent security is there. So we still believe in the fundamental security. It's offered by the secure element approach. But we think the host-card emulation can actually accelerate the mobile wallet. I mean, there's more and more discussion about the success of the mobile wallet with -- now I saw a recent report, where I think it was 1.1 billion handsets in 2017 or '18 recently. So the expectations on the mobile wallet still continue to be strong, and we see the host-card emulation is being kind of a beater or a seeding process for that overall effort.

Vivek Arya - BofA Merrill Lynch, Research Division

Got it. And maybe one last one on the financials. With the base of the -- of your growth, I think the HPMS segment will soon be at or above your long-term targets of the 24% to 29% operating margin. Is that 29%, Peter, is that some kind of structural limit or are there any drivers that can take HPMS to something above those long-term targets that you've set?

Peter Kelly

I guess, Vivek, I'd see a spin-off rate is more like about 27%. And it's -- with the kind of growth rate that we have in -- we're kind of comfortable with that, actually. One thing we don't want to do is choke off the growth in the business by obsessing over an unreasonably high EBIT number.

Richard L. Clemmer

I think we've been very specific that if it came down to squeezing out an extra 50 or 75 basis points of operating income are driving more inherent growth, we would invest to be able to drive the growth. We feel like that there's more value creation by continuing to grow well above the industry average growth rates than trying to squeeze out an extra 50 or 75 basis points in operating income.

Operator

The next question comes from the line of Craig Hettenbach from Morgan Stanley.

Craig Hettenbach - Morgan Stanley, Research Division

Within the ID business, can you talk about any changes in the competitive environment within China that you may or may not be seeing? And then also within North America, the EMV rollout, which looks to be later this year, 2015, can you just talk about kind of visibility and how you see that shaping up?

Richard L. Clemmer

Well, let me address the U.S. first. I think we see a lot of discussion, a lot of activity on EMV rollout in the U.S., but we don't think it will be a significant factor in 2014 revenue. There could be some shipments later in the year, but we expect that really to be a factor in 2015 and beyond. Relative to China, I think the position that we have, we continue to be in a strong leadership position in the dual-interface banking, contactless banking, and we'll just keep [ph] changing on that at the current timeframe, although, clearly, as we have competitive challenges as we go forward because of the leadership position we have, there's going to be more people that are going to be trying to take a piece of that. But so far so good relative to maintaining our leadership position.

Craig Hettenbach - Morgan Stanley, Research Division

Okay. And as my follow-up, nice to see the continued rebound in Standard Product gross margin. Can you talk about, as we go through 2014, maybe the influence of the cycle, any puts and takes in manufacturing and how you see that business performing through the year?

Peter Kelly

We think it's definitely benefiting from the fact that the kind of general semi markets seems to be stronger than it was in 2013. We think we'd like to see it running at about the 18%, 19% EBIT level. And clearly, we're in a position now where we'll -- to be able to continue to do that.

Richard L. Clemmer

The Standard Products is focused on profitability, not revenue growth. So what we're trying to do is ensure that we deliver on the kind of margins that we believe that business can [indiscernible].

Jeff Palmer

If I could also add to that, I think the team in Standard Products has done a very good job of trying to refocus their design win approach towards stickier opportunities in a way for maybe more [indiscernible] tight markets than they've been exposed to in the past.

Operator

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

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

Just speaking on the Automotive side, can you go over the big opportunities you see in second half '14 or into 2015 and what are the key ramps you're seeing there now?

Peter Kelly

Key ramps in Automotive?

Richard L. Clemmer

I think they really continue to be the design wins we've seen -- we've talked about in the past on the entertainment side. We've talked about that there's 28 major platforms globally on entertainment, of which we've then designed into 27. Of the 27, not are all in production, so we'll continue to monetize those over time. We're not providing any guidance for the second half, but so -- what we've said is, over a longer term, we think Automotive can grow mid to upper single digits over a multi-year period, entertainment being one of them. Keyless entry will continue to be a good driver. And then further out over probably more than 4- or 5-year horizon is car-to-car communication.

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

Got it. And then just on the free cash flow side, obviously, solid free cash flow there. But if you had to allocate between the usual share buybacks and debt reduction and M&A, how would you allocate that over the next 12 to 24 months?

Peter Kelly

Share buybacks.

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

Debt reductions, no?

Peter Kelly

No, no. I think our debt's in great shape. I mean, we're in 2x trailing 12-months EBITDA, and so -- and I'm very happy with our level of gross debt.

Richard L. Clemmer

Yes, our interest cost is now down to 3.9% on an ongoing basis, so we like our debt structure where it is today.

Operator

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

Gabriela Borges - Goldman Sachs Group Inc., Research Division

This is Gabriela Borges on behalf of James. I was hoping you could give us an update on where utilization levels are today and how comfortable are you with your mix between internal and external manufacturing capacity?

Peter Kelly

So utilization levels were 93%. Our IC business is running pretty -- well, it's actually close to 100. We're very happy with our mix of internal and external. We're gradually increasing our utilization of external foundries, particularly as we transition to 12-inch type wafers. So utilization is good. We see no issues. And our relationships with the external foundries is exactly where we want it, actually. So...

Richard L. Clemmer

But clearly, if you look at our revenue growth over the next couple years, the bulk of that will come from wafers that are outsourced from our foundry partners that will be the contributor relative to our revenue growth. And so we'll continue to see our outsourced percentage grow as we move forward.

Peter Kelly

And we have no intention of investing in a 12-inch fab or expanding our front end capacity internal.

Gabriela Borges - Goldman Sachs Group Inc., Research Division

That's helpful. And then just as a follow-up, if I may, on in and out of things in the industrial and consumer markets. Are you seeing any real demand today for these types of solutions? And are there synergies here with your portfolio of security products that perhaps give you a competitive advantage versus some of the other my [ph] control and analog companies that are also targeting growth in this space?

Richard L. Clemmer

Well, we think -- we've been talking about this more broadly for the recent period. I mean, we believe that secure connections for the smarter world, we're uniquely positioned to be able to drive the security in the connections which we think is -- as we move beyond smartphones, I mean, clearly, smartphones have the security requirement and increasing security requirement. As we move beyond smartphones to the Internet of Things, security will be a key element associated with it, and we think that we're uniquely positioned as a company to be able to provide that fundamental capability. So we do perceive that there's significant opportunities for our security capability to fundamentally drive growth on a broader base of Internet of Things and other secured connections for the smarter world.

Operator

The next question comes from Chris Caso from Susquehanna Financial Group.

Christopher Caso - Susquehanna Financial Group, LLLP, Research Division

I wonder if you could speak a bit about the inventory levels in the channel. I think your comments indicated the channel inventory is up 3 -- about 3% sequentially. Are you seeing any evidence of a general restocking, distributors and customers, as business conditions appear to be strengthening. And as a follow-on to that, could you talk a little bit about your lead times, with your utilization levels rising as having any affect, stretching out your lead times?

Richard L. Clemmer

Yes, so just the inventory is still at 2.5 months, a very reasonable level, we don't see any restocking taking place by our distributors. I think they're waiting to see their orders. Clearly, they're focused on churns and earns. It drives them to be able to keep their inventory levels at the absolute minimum that they can. And so -- but I guess the key is, while we see an improved, generally, environment, we don't see a significant ramp-up or step-up that's driving just the inventory levels. But we believe that they continue to be at a very reasonable level of 2.5 months. And I forgot your second question.

Christopher Caso - Susquehanna Financial Group, LLLP, Research Division

It was lead times.

Richard L. Clemmer

Oh, lead times. I think lead times, in general, remain about the same. Clearly, there are areas where we have some capacity limitations, like for example, in HPRF or base stations that we talked about, where lead times are completely irrelevant now. It's about capacity allocations. So I think in general, lead times remain fairly consistent, but we do have a few select areas where there is a significant increase in lead times.

Christopher Caso - Susquehanna Financial Group, LLLP, Research Division

Okay. As a follow-up, with respect to your IP business, and obviously, you had some impact to that on the December quarter. But I know that's been an area you guys have been focused on as a business going forward. Should we have any expectations for some similar licensing or other benefits as we go through the remainder of the year?

Peter Kelly

Yes, what we've talked about is we'd like to see about 100 basis points of EBIT from our IP business. I think in Q4, it was about 130. It was rather large. Q1, it was about 70. So yes, we continue to expect to see benefit from our IP portfolio.

Richard L. Clemmer

And as we've said, it will be fairly lumpy as we go through it on a quarter-by-quarter basis, but expect on an annual basis around 100 basis points of impact associated with intellectual property, and we still feel good about that.

Christopher Caso - Susquehanna Financial Group, LLLP, Research Division

And that generally will be more in the line of onetime licenses as opposed to ongoing volume-based licenses?

Richard L. Clemmer

I don't think you should draw that conclusion. I think our overall intellectual property income, we think, will generate about 100 basis points of operating income or EBIT margin, and it will be in all different forms associated with it.

Operator

The next question comes from the line of William Stein, SunTrust.

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

I'm hoping you can talk about growth in tagging applications in ID, so getting away from the areas that people tend to focus on, like banking and the emerging side of NFC. Any comment on the tagging side?

Peter Kelly

Actually, tagging is a little bit stronger for us. It's an interesting part of the business. I think we've said in the past, we thought it was -- particularly from a gain perspective, we thought it was a super niche and not something that would generate significant revenues for us. And as it's turned out, it's been quite a nice niche. It's not hundreds of millions of dollars, but it's pretty positive. We begin to see -- continue to see nice trends, and it's quite a profitable line for us.

Richard L. Clemmer

Yes, I think the -- clearly, we've seen it move into a broader base of application, then just tagging for inventory purposes or books and all the things that people have talked about in the past. But it -- as we look at some of the consumer applications, we have won now a second major consumer design win. And originally, in the -- gained Skyline there. We talked -- we've had shipped about 10 million units or something, and we've shipped well over 100 million units. So I mean, it is a contributing factor but not a major factor in moving the needle for the total company. It's a nice business, it contributes, but not something that's going to move the needle for the total company at all.

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

Great. And as a follow-up, I want to turn one of the earlier questions on its head a little bit regarding capital allocations. Someone asked about debt, buyback. When I look at my model, and I look towards the end of 2015, if my gross margin assumption estimates are right. I show net leverage metrics of in the low 1s, like 1.3. And I have to ask myself, is that the right leverage level for this kind of company? And could you potentially raise that to do more buybacks in, let's say, 1.5 years kind of timeframe if you don't find another use of cash, like M&A?

Peter Kelly

I'd agree with you. I think 1x is probably too low a level of net debt to trailing 12-months EBITDA. But we'll -- as we go through 2015, we'll see what we want to do there. Certainly, taking on more debt to buy back stock or -- that's -- we don't have anything that we want to report, but maybe at some point, we would want to do some M&A. So yes, I'd agree with you completely, I think 1x would be far too low a level for us.

Richard L. Clemmer

I think the way to summarize it is, is we feel very comfortable with our current debt structure today. Net interest cost that's 3.9% is -- and 75% of it fixed rates, we think, and 75% of it unsecured is a good position to be in. As far as out 1.5 years or so, I think we'll have to see where we are at that point in time.

Peter Kelly

We're right with you. We agree with you, okay?

Operator

The next question comes from the line of Steve Smigie from Raymond James.

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

Just quickly on the bank card market, as you're getting your incremental design wins or having discussions in China and then in the U.S., are you finding what's happening is your 3 major customers are gaining share in those markets? Or are you more having discussions, where you're getting wins with new customers that are existing card makers in these markets already?

Richard L. Clemmer

I don't know exactly how to respond to that. I think that the leadership position that we have in the developing countries on contactless banking, we continue to see a very solid position. We think that, that could be -- as the overall volume continues to grow, we could see that market share that we have go down 10 or 20 points or so over some period of time because it's hard to maintain the high levels of market share we have. But we think that as the EMV market in the U.S. grows, we see no reason we shouldn't have the same kind of market share that we do in contactless banking on a worldwide basis. And we think we're positioned to do that. If we're -- whether that comes from -- which customer it comes from, I think, is something that we probably should let them talk about as opposed to trying to do the projections associated with that.

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

Okay, great. And then on the Portable & Computing business, I think you talked about it being flat sequentially. You guys have -- generally, you've had some nice design wins there. Overall, should we think about the seasonality for that business, really? We would see maybe the third quarter would be maybe your strongest seasonal quarter, is that the right way to think about that?

Richard L. Clemmer

Yes.

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

Okay. And if I could sneak one more in just -- in terms of the in-vehicle networking, where you expect to see the strengths, say, over the next year or 2, is it -- would that be more still on LAN and CAN, FlexRay stuff? Or do you think it could be more growths or maybe Ethernet-type applications?

Richard L. Clemmer

We think -- we're trying to be sure that we have a strong position on the Ethernet side, but we don't think that will be a significant factor on growth for the next year or 2. We think it'll continue to be FlexRay and CAN, CAN/LIN, but with some integrated CAN/LIN as well. So there is some integration that's taking place that drives some of that, but we would not expect Ethernet to be as strong a growth factor in the near term. We think that's a little further out in time. And clearly, our position in vehicle-to-vehicle communications outside of the vehicle itself is really where we want to be sure that we can demonstrate the fundamental leadership technology that we have and continue to drive the market place for the safety opportunity that comes from vehicle-to-vehicle communications. And you're beginning to see much more broader acceptance of that. In the U.S., the Department of Transportation now has come out endorsing vehicle-to-vehicle, have not said they will enforce it but at least endorsing it. And we think the opportunity there is very significant, although it'll be out in time several years as opposed to something that would be in the next few quarters. And we want to be sure that we continue to be in a strong leadership position there on vehicle-to-vehicle.

Operator

The next question comes from the line of C.J. Muse from ISI Group.

Christopher J. Muse - ISI Group Inc., Research Division

I guess, first question, in terms of your outlook for a faster ramp in ID in the back half, as well as seasonally strong mobility in Q3, curious what your early read is on Q3 sequential growth relative to typical seasonality, if there is such a thing?

Peter Kelly

No, we don't actually guide Q3, Q4. What Rick was talking about before is, on a number of occasions, we've talked about the kind of medium -- the medium-term growth expectations, i.e., over the next 3 years, on a compound annual basis. But really not appropriate for us to try and guide Q3 or Q4 at this stage.

Christopher J. Muse - ISI Group Inc., Research Division

It was worth asking. I guess, second question, in terms of share buyback, curious how we should think about how we model buyback versus dilution from share grants to employees.

Peter Kelly

I think there's a couple of things there. Obviously, forecasting this stuff is actually quite difficult and -- nigh impossible for you guys, which is why we give a number for the next quarter. What -- one thing I would say, which is a number that it's probably difficult for you to get to is a $5 change in share price actually increases or decreases dilution by about 1 million shares. And then, of course, the big move in any particular quarter, you only get the kind of weighted average in -- so the most you could get -- the highest impact you can get from a buyback in any quarter is probably 2/3 of it, if we did it right after the earnings call. In terms of our overhang, our common stock is about 252 million shares at the moment. We have about 22 million equity brands [ph] outstanding. But I have about 10 million shares in Treasury, so a simple overhang is only about a 4.5% at the moment. But to be honest, it is difficult for you to forecast it, which is why we give you the Q2 number. And it's difficult for me to give you a Q3 and Q4 number because I don't know what we're going to do from a buyback perspective.

Richard L. Clemmer

Nor what the stock price.

Peter Kelly

Nor what the stock price is going to be [ph]. And our [indiscernible] dilution is about less than -- it's less than 2%, and that's helpful as well.

Christopher J. Muse - ISI Group Inc., Research Division

That's helpful. And last question for me. Considering the pull-in of some OpEx related to IP project, curious how we should think about sort of any onetime lumpiness up or down in OpEx going into the second half.

Richard L. Clemmer

No. I think it's -- clearly, we're -- we pulled it in to be able to meet the technology requirements of our customers so that we can support the ramp-up on a product capability. And I don't think it's going to be lumpy, it's just we've pulled in that increased investment that we planned and associated with it.

Peter Kelly

And not from an OpEx perspective but from a cash perspective, I just thought I should probably have mentioned, in Q2, we have our 2013 bonus payments. So from a cash perspective, there'll be about -- I want to say about $55 million, $60 million in Q2. That's a big lump of cash-out that relates to the 2013 bonus achievement. But that's obviously not an OpEx issue.

Operator

The next question comes from Ambrish Srivastava from BMO.

Ambrish Srivastava - BMO Capital Markets Canada

Peter, I just had a question on the EBIT target, and I just want to make sure I get it right. On the one hand, you said on the HPMS side, that you're comfortable with where it is. But then earlier on, like you said, that -- I think, Rick, you said that you have a maniacal focus to get to 26%. So where is that trade off? Should we think about Standard Product? Is that what's going to get you there? What's -- am I thinking it right?

Peter Kelly

Let me have a go with that. I think Standard Products should run about -- if it runs 19%, we should be able to get to 26%. So the HPMS does have to improve a bit, but the idea of HPMS going up to 30% or something from the 27% it is today, it's not going to do that. I mean, if you do the math, you can work it out. It doesn't require a big improvement in HPMS to consistently get to 26%. The thing we're really focused on is -- and you may see some lumpy things on a quarterly basis. But on an annual basis, we'd really like to run significantly ahead of the industry on revenue growth with a 26% EBIT level. And then given that we don't really pay much in the way of tax, a lot of that falls through to earnings and cash and is generally a very virtuous cycle. So that's really the message we're trying to get out.

Ambrish Srivastava - BMO Capital Markets Canada

Okay, that's helpful. And then a quick clarification, and I apologize if you did address it in the beginning. What's guiding the growth in the I&I for the second quarter?

Richard L. Clemmer

We talked about HPRF per base stations and the strong demand that we have and being able to meet the -- trying to be able to meet, not meeting, our customer requirements associated with it. It's being a significant factor. But...

Ambrish Srivastava - BMO Capital Markets Canada

And that's largely in China?

Richard L. Clemmer

I wish -- our customers are telling us that it's much more broad based. And then we also have our emerging business, where we have some new development that will drive some growth associated with the success we've had on the audio design wins quite broadly in China in -- with the smartphones. And some growth in POS [ph], where we have smart lighting, where we're being successful with the deployment associated with smart lighting and LED drivers.

Jeff Palmer

So really, Ambrish, it's really across the whole portfolio in the Infrastructure & Industrial group but driven by the base station end market.

Operator

The next question comes from Liwen Zhang from Blaylock Robert Van.

Liwen Zhang - Blaylock Robert Van, LLC, Research Division

Would you please give us update on the works protest in Netherlands and the impact on the gross margin?

Peter Kelly

Yes, no, it was resolved several weeks ago, and it was resolved very amicably. Had no impact on outputs and no impact on gross margin. We have a very, very good relationship with our employees and our works council in the Netherlands and, I guess, in all of our locations, actually.

Richard L. Clemmer

So if I could just add, I think during the process of the negotiations, there were a couple of basically one-hour demonstrations over lunch on the site, which was not significantly disruptive to gross margin or the production.

Peter Kelly

They're not disruptive at all.

Liwen Zhang - Blaylock Robert Van, LLC, Research Division

Okay. And then my next one, actually. Also the last one. And how about the impact from the facility damage at Japanese supplier for Furukawa Electronics?

Peter Kelly

Yes, we have a very robust program to help us in the event of natural disasters. And unfortunately, we've been able to use that several times in the last few years: initially, with the Japanese tsunami; and then with the Thai floods. It's proved to be -- the damage in Japan has proved to be a challenge. It's required us to do a number of things. But to date, it's had no impact on our revenue, and we don't expect it to as we go forward.

Operator

And the final question comes from Suji De Silva from Topeka.

Sujeeva De Silva - Topeka Capital Markets Inc., Research Division

In terms of the Standard Products, can you talk about -- I know you've been through an up cycle now, but any structural changes that are happening under the covers in the portfolio or efficiencies that we can we have a better trough peak range in the next cycle?

Richard L. Clemmer

Well, I think the key is more focused on the customer and product selection associated with Standard Products. So the team has done a really good job of being -- of changing their customer mix away from the Computing side and more towards the Infrastructure and Automotive side, which proves to be much more sticky on design wins and a little bit different characteristics on pricing. So we're hopeful that it will give us more stability in overall margins of that business, although we'll have to prove it. But the bottom line is, is that we're much more focused on margins than revenue. And the guys have delivered on changing mix and performed fairly well associated with that. We're pleased with the progress they've made in the most recent quarter and see no reason we can't continue that for the next quarters.

Sujeeva De Silva - Topeka Capital Markets Inc., Research Division

Great. Sounds constructive. My last question is on the acquisition environment you're seeing now, is it target rich? Do you think the valuations are stretched? Are there any product holes or new areas that would be focuses. And lastly, currency there, would you think about using your stock or would it be cash?

Peter Kelly

It's always hard to talk about acquisitions. I guess, the smart answer from me would be they're all outrageously expensive. Unless they bring [ph] the 5%, it's never going to happen, except for us. I -- no, I just think it's an impossible question to answer, actually.

Richard L. Clemmer

I think harder than you think [ph]. The only thing that we could say is, is that as we've been talking about for the last few quarters, where -- historically, we would not have been active in the M&A market because of our maniacal focus on reducing our debt. Our capital structure now allows us to be in consideration associated with that, but we don't have anything at all to talk about at this point in time.

Sujeeva De Silva - Topeka Capital Markets Inc., Research Division

Rick, would you kind of play in a new area of growth or fill in product holes, just generically?

Richard L. Clemmer

I think that's a level of detail that we shouldn't even think about. I think the key is, is that our capital structure is supportive of at least considering it at this point in time. We think that, organically, we can continue to outgrow the industry, but if it positions us better, then obviously, we would consider some things.

Thanks a lot. So we thank all of you for your continued interest in NXP. The key points that we'd like to highlight in the progress through 2014 are the continued revenue growth at a robust level that we believe is better than our peers, with an overall revenue in Q1 that was actually up 14% on a year-over-year basis. We think the improving and stable profitability, with Q1 gross profit dollars up 15% and operating profit dollars up 18% on a year-on-year basis. And clearly, our focus on cash generation has resulted in strong cash generation, with 19% free cash flow and 179% year-on-year increase and basically returning $828 million in share repurchases over the last 12 months. So thanks a lot for your support, and look forward to talking to you. Thanks.

Jeff Palmer

Thank you, everyone.

Operator

Thank you for joining today's conference. This concludes the presentation. You may now disconnect. Have a good day.

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