Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

NXP Semiconductors N.V. (NASDAQ:NXPI)

Q2 2014 Earnings Conference Call

July 23, 2014 8:00 AM ET

Executives

Jeff Palmer - VP Investor Relations

Rich Clemmer - CEO, President

Peter Kelly - CFO, EVP

Analysts

John Pitzer - Credit Suisse

Blayne Curtis - Barclays

William Stein - SunTrust

CJ Muse - ISI Group

Ambrish Srivastava - Bank of Montreal

Vivek Arya - Bank of America

Ross Seymore - Deutsche Bank

Craig Hettenbach - Morgan Stanley

Chris Caso - Susquehanna Financial Group

Vijay Rakesh - Sterne, Agee

Steve Smigie - Raymond James

Sujeeva De Silva - Topeka

Jim Covello - Goldman Sachs

Operator

Good day, ladies and gentlemen, and welcome to the Q2 2014 NXP Semiconductors NV Earnings Conference Call. My name is Susan, and I'll be your operator for today. At this time all participants are in a listen-only mode. We will conduct a question-and-answer session towards of this conference. As a reminder, this call is being recorded for replay purposes.

I'd now like to hand over to Mr. Jeff Palmer, Vice President of Investor Relations. Please proceed, sir.

Jeff Palmer

Thank you, Susan, and good morning, everyone. Welcome to the NXP Semiconductors Second 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 second quarter 2014 earnings press release, it can be found in our company Web site under the Investor Relations section at nxp.com. Additionally, we have posted on our Investor Relations Web site 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 Web site.

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 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 second quarter 2014 earnings press release, which will be furnished to the SEC on Form 6-K and is available on NXP's Web site in the Investor Relations section at nxp.com.

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

Rick Clemmer

Thanks Jeff, and we welcome everyone to our earnings call today. We are really pleased to be here as our results and guidance today mark major milestone in the growth story that is NXP. Many of the design opportunities we have discussed over the last several quarters and before continue to see significant and material traction. As our third quarter guidance reflects, we believe the momentum should continue into future periods.

Turning to our results for the second quarter, they were very good and overall above the high-end of our guidance. Our results reflect strong broad-based revenue performance, good operating profit growth with incrementally higher operating expenses as we continue to invest for future growth. Product revenue was approximately $1.3 billion an 8% sequential improvement and up 13% versus the prior year period. This was a new record of NXP since the IPO with nearly all of our business lines delivering revenue performance above our expectations. Total NXP revenue was approximately $1.35 billion also an 8% sequential increase was approximately 14% from the year ago period.

Turning now to our segment performance HPMS revenue was just under a $1 billion at $988 million an 8% sequential increase and up nearly 13% from a year ago period. We believe our HPMS revenue growth continues growth in excess – well in excess of our peer group, a clear proof point that our HPMS strategy can consistently deliver growth in excess of our industry peers.

And now, I would like to review the results for our various HPMS businesses. Within our ID business, revenue was $343 million, up 8% versus the prior quarter in line with our expectations and 1% growth on a year-on-year basis. Remembering the year ago period was influenced by strong initial ramp on an initial stocking of our China banking business which as you would expect has an impact on the year-to-year comparison.

Order trends within core ID business were solid with revenue up 5% sequentially. Growth within core ID was driven by good demand across nearly all product lines especially in banking with slight sequential declines that we had anticipated in the eGovernment business. 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 up 22% sequentially but down about 1% versus the year ago period.

Moving now to our P&C end market, revenue was $147 million, a 9% sequential increase and a 39% from the year ago period. This was $10 million better than the upper end of our expectations primarily due to broad based market – multi-market demand for both interface and NCE products.

Within our infrastructure and industrial business, revenue was $210 million up 15% sequentially and up about 17% versus the year ago period. During the quarter revenue was inline with our original expectations as base station OEMs drove the majority of the increase. For our emerging business and car lighting business were both up sequentially.

Within our automotive business, revenue was $288 million another strong quarter though a just bit below expectations. Revenue was up 4% quarter-on-quarter and up 14% versus the second quarter of 2013. From a product perspective we experienced strong sequential demand for entertainment products, while keyless entry and in-vehicle networking solutions were both up modestly.

Finally, turning to our Standard Products segment, revenue was $316 million better than anticipated resulting in a 7% quarter-on-quarter growth and up a strong 12% versus the year ago period. We continue to experience better mix in the business driven mostly by the general discrete portion of the business. I would like to acknowledge the hard work of the standard products team as cut in over the last year. They are gaining market share, delivering improved profitability and focusing on more defensible long-term opportunities.

Turning now to our distribution channel performance. Total sales in the distribution were up 9%, with sales out of distribution up 4% as we position material ahead of an anticipated strong Q3. The total months of inventory in distribution channel were 2.6 months inline with our longer term models. Absolute dollars of inventory in the channel increased about 8% on the sequential basis.

In summary, our overall results in Q2 were very good, with better overall product revenue, better operating profit and good free cash flow. And can be seen in our earnings release we are anticipating another strong quarter in the Q3. 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 generations.

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

Peter Kelly

Thank you, Rick. And good morning to everyone on todays call. As Rick has already covered the drivers of revenue, I'll move directly to the highlights of the quarter.

Overall, Q2 was a very good quarter and at the high end of our expectations. Total revenue, non-GAAP gross profit, operating profit and net income were all better than the midpoints of our guidance and non-GAAP EPS was $1.09 from $0.04 above the midpoint.

Focusing on the details of Q2. Revenue was $1.32 billion, $123 million above the midpoint of our guidance and $103 million increase from Q1. We generated $655 million in non-GAAP gross profit or 48.6% non-GAAP gross margin, about $16 million above the midpoint of our guidance and $38 million better than Q1 due to better than expected revenue performance on an improved mix.

Now let me turn to the operating segments. Within the HPMS segment, revenue was $988 million, up about 8% versus the previous quarter. HPMS non-GAAP gross margin was 55.4%, 60 basis points below the Q1 while non-GAAP operating margin was 27.8%, 50 basis points above the prior quarter.

Within our Standard Products segment, revenue was $316 million up 7% sequentially. Standard Products non-GAAP gross margin of 33.2% was flat versus Q1 on a percentage point basis. And non-GAAP operating margin was nearly 20% up 190 basis improvement sequentially. Really is pleasing to see our Standard Products recovered as we indicated it would over the last year and is now solidly within the range of excellent profit performance.

Total non-GAAP operating expenses were $322 million, up $5 million on a sequential basis as we continued investments in support of major customer programs as well as accruals for incentive compensation better than expected market share growth and progress towards profitability goals.

From a total operating profit perspective, non-GAAP operating profit was $334 million and represents a 24.8% operating margin, up about 60 basis points versus the prior quarter. Interest expense was $34 million; non-controlling interest was $19 million and cash taxes were $8 million in (indiscernible).

Total NXP non-GAAP earnings per share were $1.09 towards the high end of our guidance on $0.11 better on a sequential basis. Stock-based compensation, which is not included in our non-GAAP earnings, was $37 million.

Now I'd like to turn to the changes in our cash and debt. Our total debt at the end of Q2 was $3.58 billion essentially flat on a sequentially basis. And cash at the end of quarter was $661 million. We exited the quarter with a trailing 12-month adjusted EBITDA of approximately $1.49 billion, and our ratio of net debt to trailing 12-month adjusted EBITDA at the end of Q2 was 1.97x inline with our target of 2x. We bought back 3.8 million shares at a cost of approximately $223 million or a weighted cost of about $59.40 per share.

Turning to our working capital metrics. Days of inventory were 96 days a decrease of 6 days sequentially and excluding prebuilds associated with the restructuring of our fabs, our effective DIO was 88 days. Days receivable were 43 days, while days payable were 80. Taken together, our cash conversion cycle improved to 59 days from the 66 days reported in the previous quarter.

Cash flow from operations was $242 million, and net CapEx was $89 million, resulting in positive free cash flow of $153 million or 11% free cash flow margin. Free cash flow was a little less than previous quarters as we paid our bonuses and in 2013 on a slightly higher restructuring cash out payments of about $28 million.

Now I'd like to provide our outlook for Q3. Based on our analysis that appears we are continuing to gain market share across the product portfolio and we anticipate NXP should continue to substantially outperform the overall market.

We continue to have a number of company specific programs, which we see contributing to solid growth in future periods. With this as a background, we currently anticipate product revenue will be in the range of up 10% to up 13% sequentially. At the midpoint, we expect product revenue to be up in Q3 about 11%, reflecting the following trends in the business, all on a sequential percentage basis.

Within our HPMS segment, we expect Automotive to be flat to slightly up sequentially; Identification is expected to be up in the mid teens range; Portable & Computing is expected to be up in the 40% range at 4-0; Infrastructure & Industrial is expected to be up in the low-teens range; Standard Products is expected to be up in the low single-digit range. We anticipate revenue from the combination of manufacturing and Corporate and Other to be approximately $43 million. So taken together, total NXP revenue should be in the range of $1.47 billion to $1.52 billion, or about $1.495 billion at the midpoint.

We expect non-GAAP gross margin to be about 48% to the midpoint plus or minus. And operating expenses are expected to be in a range of $330 million to $340 million, about $335 million at the midpoint or 23% of the revenue which is still under our target metric of 24%. This translates into a non-GAAP operating profit in the range of $370 million to $395 million, or about 26% operating margin at the midpoint.

Interest expense on our debt should be approximately $35 million. Cash taxes are expected to be roughly $7 million, non-controlling interest expense should be about $17 million and stock-based compensation should be about $34 million, which is excluded from our guidance. Diluted share count should be about 250 million shares, but obviously depends on share price fluctuations and the level of buy backs we execute. Taken together, this translates into non-GAAP earnings per share in a range of $1.25 to $1.35, or $1.30 per share at the midpoint of our guidance, so an excellent quarter, strong guidance.

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

Jeff Palmer

Susan we will for questions now.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Your first question comes from the line of John Pitzer of Credit Suisse. Please go ahead.

John Pitzer - Credit Suisse

Yes. Good morning guys, thanks for letting me ask the question, congratulations on strong results. I want to focus my question and follow-up really on some of the sub-segments driving growth in the September growth. I guess my first question, within the ID guidance for September, can you help me better understand what's coming from core ID versus the more emerging ID and within the core ID bucket, are we starting to see kind of the banking business come back or the eGovernment come back a little bit of color there would be helpful?

Rick Clemmer

So I think the key John is on banking, China banking was really strong Q2 a year ago, when we really had the stocking into play. So China banking even in our Q2 results as come back but it's not as high as the year ago basis because again that was more on a stocking basis. So I would say our China banking business now is back at more of a steady state basis slightly below where it was a year ago – a year ago Q2 but very strong. Clearly, when you look at Q3, we will have a significant portion of our growth it will come from the emerging ID business but we haven't broken out the details of that and just we would like to anticipate growth for the total ID business.

John Pitzer - Credit Suisse

And then Rick, on the industrial and infrastructure, I know that you have been trying to kind of balance the strength coming from base stations with the capacity you have, yesterday we kind of I guess Tuesday night, we kind of got a data point from the PLDs that maybe there is a pause going on there. You guys kind of guiding I&I up pretty significantly in the September quarter. Is that again, another base station driven event or can you help us understand what's driving the growth there for September?

Rick Clemmer

For September, we expect strong growth in base stations, we have been capacity limited in supporting our customers and been hand to mouth actually constraining the shipments that they could ship based on the power amplifier which is not the position we like to be in. We tried to base this business for where we can have a nice profitable growth as opposed to a bombast cycle. So we have actually frustrated some of our customers in the near term not being able to meet all the requirements but anticipate strong growth in Q2.

And to be fair as we talked to our base station customers it's much more broad than just China LTE, the customers that we have in and if you will think about over the last few quarters John, one of the things that we see in the base stations is the growth of some accounts where weren't designed in before. So we are actually growing more than just the basic demand as we gain share in the near term based on the design wins we have. But, it's clearly been limited based on our manufacturing capacity. We bring on some additional capacity in Q3 and that will clearly give us the position to be able to support our customers in a little bit more significant fashion than we were able to do in Q2 and hopefully not had quite as many customer visits to explain their frustration with our like up support.

Peter Kelly

And John, it's Peter. Certainly base stations is doing quite well and Rick explain that. We are also seeing in that segment, our TLS business is doing fine and our emerging business is also doing very well in particular our mobile audio. So it's not just base stations.

John Pitzer - Credit Suisse

Thanks guys. Congratulations again.

Rick Clemmer

Thanks John.

Operator

Thank you. Your next question comes from the line of Blayne Curtis from Barclays. Please go ahead.

Blayne Curtis - Barclays

Hey, guys great results. May I can about the other segment Portable & Computing up 40%, to the extend you can talk about it, maybe difficult maybe in the context of do you have new ramps that you are adding in this sector or is it similar products just getting more penetration, is there anyway you can kind of breakout where that's strength coming from?

Rick Clemmer

Vijay, I think the key was that it was broad based. It was across our macro which is – Blayne, sorry Blayne.

Blayne Curtis - Barclays

Yes.

Rick Clemmer

It was broad based across our interface and macro. So we would not – it was not any ramps key programs in Q2. We do expect to see some of those in Q3, the guidance that we have. But, this was really broad based with design wins that we've won with the acceleration of those on a very broad based with most of that actually going through the distribution channel.

Blayne Curtis - Barclays

Got you. And then maybe just following back up on your infrastructure comments. Do you think now given where you are shipping to in September that you are going to be caught up and if you can just comment, I mean I think you have done a good job managing this versus some others who have shipped ahead and off to correct? Are you seeing any sort of pause in China more directly that others have mentioned.

Rick Clemmer

We are seeing that at all Blayne. What we are seeing is, is that our customers tell us we are still not meeting their full requirements. But I think the one thing that we as well as our base stations customers, they are seeing broad based demand. I mean in Q2, there was one of the issues we struggled to be able to support the growth in Latin America supporting deployment associated with the World Cup. But, there is a broad based base station demand in the Middle East and Africa and well beyond just China that we understand from our base station customers and we are still not meeting the requirements.

Now we are taking the opportunity and working with our customers to be sure that we secure longer term run rates and orders with these base station customers as well. So it's – we created frustration for them but we have done as good a job as we could working through that and now trying to be sure that we secure longer term business on an ongoing basis with the intent again to make it a profitable growth business and not focused on doing best cycle.

Blayne Curtis - Barclays

Thanks guys.

Rick Clemmer

Thanks Blayne.

Operator

Thank you. Your next question comes from the line of William Stein, SunTrust. Please proceed.

William Stein - SunTrust

Hey, guys, thanks for taking my question and congrats on the very strong guidance. Maybe I'm going to go at Portable & Computing guidance a bit of a different way. Can you help us understand the – maybe the relative level of concentration in terms of customers and products that are driving the very strong guidance there is it? I'm sure it's not one customer, one product, but maybe give us a sense as to how concentrated or diversified that growth is going to be?

Rick Clemmer

I think the key thing is to not just talk about Q3 but to talk about Q2. As we talked about our Q2 results which were extremely strong, we see that on a broad base -- customer base. So with broad number of design wins from early through the distribution channel, clearly, we have some key design wins at some of the leading smartphone and tablet company in Q3 that will be a significant factor in our Q3 growth. But it's not just in a single customer concentration. There is a broad based growth with really the design wins in the smartphone and tablet area being incremental growth over and above that.

William Stein - SunTrust

That's helpful. Maybe shifting to another area, I think you didn't talk about, I believe that the company got a design win for it's [V2X] (ph) or 80211-E product in the quarter and it seems to me that's fairly compelling product area. I'm wondering if you can talk a little bit about what we see the – maybe in the longer term opportunities there? Thank you.

Jeff Palmer

William, this is Jeff. We did talk about that we had – and ordered the first design on our Car-to-Car communication program. The automobile industry works in a different cadence and just about any other industry. That design will go into production until the 2017 model year, surprise to see it late 2016. So it's still quite a ways away from being real revenue. But we are pretty excited about that discussions with other major auto OEMs are going very positively.

What was kind of interesting about the award on the Car-to-Car communication was also it's not just the communication part that was – we were seen as being superior to, it was the security that we brought into the system. So it was a very, very -- very good award for us in that perspective.

William Stein - SunTrust

That's great.

Rick Clemmer

Yes. I think we are really encouraged about the opportunity of driving a total solution base there then providing a security as well as the overall connectivity really placed our strength as we go forward and what we are trying to accomplish as a company. And as Jeff said, it will be a few years before it ramps. But, we clearly one of the leader in that space and true that we are thought leader in the Car-to-Car, vehicle-to-vehicle communications.

William Stein - SunTrust

Great. Thanks very much.

Jeff Palmer

Thanks Will.

Operator

Thank you. Your next question comes from the line of CJ Muse, ISI Group. Please proceed.

CJ Muse - ISI Group

Hey, good morning. Thank you or good afternoon. Thank you for taking my call. I guess first question, tell us if you can kind of talk about the sustainability of the outside growth that you are seeing in P&C and ID, love to hear your thoughts in terms of leverage to the breadth of customers you talked about as well as any individual product cycles that we should be thinking about?

Rick Clemmer

I don't think we want to get in – back into the discussion of individual product cycles and individual product designs. I think the thing that we see is clearly the opportunity for the mobile wallet to finally begin to emerge as the kind of expectation as we have had for quite some time. And with some of the new used cases being a significant opportunity in driving the results.

So I guess the only thing we can really say CJ is, we are giving you pretty good guidance relative to the revenue growth, we don't think it's a one shot pop. We think this is a sustainable systemic change of the fundamental core of the business where you will see mobile wireless and clearly the interface designs that we have had contributing in the microcontroller design wins contributing on the P&C side. But we see that on a sustainable basis. We don't see that it's just a near term pop.

Peter Kelly

Yes. CJ, its Peter. One of the things we have been talking about is kind of long-term compound annual growth rates over the years. We still see P&C has been kind of mid-teen sustainable growth rate over a number of years.

CJ Muse

Okay. Very helpful. And then if I could follow-up Standard Products below a quarter great operating margins, I guess how should we think about growth from here and there and as well as, is there more juice on the operating side or should we be thinking around 20% go forward?

Rick Clemmer

Well, 26% on operating income.

Peter Kelly

If the Standard Products – few years ago it ran well over 20% but that was in a really, really unusual market. So I think Standard Products running between 18% and 20% is super, super solid. We would expect it to grow inline with the semi-market generally. And of course, we are very focused as Rick says in total company level that one is 26%.

CJ Muse

And I guess to follow-up there, were there any particular drivers of strength there, or is it just broad based?

Peter Kelly

It's broad based. Discrete and it's basically we think a reflection of the kind of current strength in the semi-market.

Rick Clemmer

It was really in transistors and diodes where we saw the strength this quarter and we think it's well served. And so long as we can run as Peter said 18% to 20% then that gives us the support we need to be able to run the 26% operating income for the total company.

CJ Muse

Perfect. Thanks so much.

Peter Kelly

Thank you.

Rick Clemmer

Thanks CJ.

Operator

Thank you. Your next question comes from the line of Ambrish Srivastava, Bank of Montreal. Please proceed.

Ambrish Srivastava - Bank of Montreal

Thank you. A question on the more broader businesses that you serve. And we always thought about the cyclical factors, what are you seeing in terms of lead times orders, channel inventory, the more broader end. And then, I had a question on free cash flow, CapEx ticked up a little bit for the year, should we still be thinking in the 5% range in terms of capital intensity? Thank you.

Rick Clemmer

Well, so, on the channel inventory we talked about it being a 2.6 months, so still well within the balance where we would like it to be. It increased slightly in the quarter on a dollar basis as we prepare for the increased revenue in Q3 be able to meet our customer requirements. But, I think that where we are as an industry is we are now beginning to see an improvement in demand. So I think we has an industry had been waiting to see China and I think when you really get down to it the demand improvements are here. And it's looking fairly attractive. So the positive thing for us is, as we have some incremental demand through the design wins that we have that actually position us better than just a general industry growth.

So I would say that unlike where we have been over the last couple of years where we said, we felt like the industry really worth of seeing a strong growth. But we have been able to drive design wins and now we are beginning to see growth in the industry with the incremental design win striving growth over and above that.

Now, let Peter talk about the CapEx.

Peter Kelly

CapEx. CapEx, we could really try and run 5% through the cycle. To be honest this year probably will be a little bit higher my guess is maybe 5.8% of revenue. Our CapEx tends mostly to actually be in the backend and particularly in test of the CapEx level what you spend in our frontend fabs is, is relatively small and tends to cover how we boast particular bottle mix as opposed to large scale investment, so capacity is increasing, our growth is covered external sources.

Ambrish Srivastava - Bank of Montreal

Hey, great. Thank you.

Jeff Palmer

Thanks Ambrish.

Operator

Thank you. Your next question comes from the line of Vivek Arya of Bank of America. Please proceed.

Vivek Arya - Bank of America

Thank you for taking my question. Rick, I'm curious in emerging ID mobile banking, are you seeing demand for just NFC controller chips, or are you seeing also healthy attach rate for the secured element. And if there is anyway to quantify what the attach rate of secure element is today and what it can be next year?

Rick Clemmer

As we know and you know a different – our customers have different architecture associated with it. I think as we go forward, but we think will be the game changer that really proves the ease of use. It will have a combination of secured element, the radio. So we feel very comfortable with the strength of the secured element and continuing to contribute to the business. But, there will be certain of our customers that will just use the radio without having a secured element.

So it's not like we can push – point to any single direction associated with it. But I would tell you that we were excited about the growth going forward, the secured element will deploy a significant share of that mobile wallet opportunity.

Vivek Arya - Bank of America

Got it. And maybe just to clarify that and then my follow-up question. So the clarification would be that in terms of content then is it then fair to assume that your average content in emerging ID hopefully stays similar to what you are getting today. And then my follow-up question is just your view of industry consolidation, you have obviously shown a very good sales growth and you have achieved your operational and that delivering objectives as the first milestone you had set out. So what is the next major milestone for NXP? And do you think it will perhaps need some inorganic transaction? Thank you.

Rick Clemmer

Well, on the industry side, I guess what we said, we started seeing kind of late last year was now that we have our capital structure or our net debt is below 2x annualized EBITDA, we feel very comfortable with our capital structure and like our debt structure where it is, even basically 75% of it being unsecured and locked in at 3.8% Peter?

Peter Kelly

Yes.

Rick Clemmer

Overall debt cost, so we feel very comfortable with the debt structure where we have it. So we think that gives us the opportunity to think about acquisitions that we wouldn't have thought of through kind of the end of last year. As you can tell that we are not going to be running out quickly and buying something just to be able to buy something. We will be very patient. What we would want to do is, focus on something that will expand our one of our key franchise areas, our true leadership positions and strengthen that. It would have to be significantly accretive and we want to be in a position where we could be back at the 2x annualized EBITDA basis within three to five quarters.

So that said, we are not going to do a $5 billion or $6 billion M&A deal. But, we would have the tendency to be limit that to more like a couple of $1 billion. But, we would be very patient and very careful on our first transaction as we think it's important to be able to continue to support the organic growth that we have and demonstrate to our shareholders the opportunity to really exist with the company as it is today. But, we do have the opportunities now to think about inorganic growth in an additive to that growth that we both portrayed and talked about from the core NXP business.

Peter Kelly

Which is exactly what we have been saying I guess for the past nine months now.

Rick Clemmer

Right.

Vivek Arya - Bank of America

And content on emerging – you think that's stays roughly similar to what you have right now?

Rick Clemmer

Yes. I think clearly we will continue to have some customers that would just use the radio and some that we use the radio and secured element. We think that the real killer app would be – we will have the radio plus the secured element which provides the security to really be able to protect individuals' wallets. We think that if somebody is using the radio then there is a weakness, they are trying to use software as the security and clearly that exposes it to additional hacking issues. And so we think the secured element plays a very key part of the total mobile transaction solution that provides the security that we all want to have of our individual wallet.

Vivek Arya - Bank of America

Okay. Thank you.

Rick Clemmer

Thank you.

Operator

Thank you. Your next question comes from the line of Ross Seymore, Deutsche Bank. Please proceed.

Ross Seymore - Deutsche Bank

Hi, guys. Congrats on the strong quarter guide. Thanks for letting me ask you a question. The automotive market, big market for you guys across a couple of different segments, can you give us a little more color why that was a little bit weaker than expected in any other dynamic you are seeing going forward in it?

Rick Clemmer

Yes. It wasn't really anything of significance. I think it was just kind of some shipments at the end of the quarter that kind of got held up. So I wouldn't take any indication of the weakness in the business based on the results that we have in Q2. We continue to see really strong growth in automotive business. Our position is especially in the car entertainment now having – basically all of the mid and high car radio platforms that use our technology that's still ramping at a number of those as they transition. And then the true leadership position that we have in the remote keyless entry as well as the in-vehicle networking in a very strong position.

And so really the key for us has been the emerging areas that we talked about the design win on the vehicle-to-vehicle and being in a position where we can be a thought leader in that space and in some of the other emerging technologies that we think can play a role in growth in automotive that we will talk more about it in our Investor Day in November.

Ross Seymore - Deutsche Bank

Great. And I guess it's my follow-up switching gears over the gross margin thought side for Peter. I know in your guidance the operating margin is improving nicely, the slight drop in the gross margin, can you give us a little color, is that just mix, is it mix between segments, mix within the segments, anymore color would be helpful? Thank you.

Peter Kelly

I think it's a number thing. It's mix – probably mix within segments rather than between segments. And then the ramp of some new products, so I don't say it's kind of split pretty evenly between the two of those.

Ross Seymore - Deutsche Bank

Great. Thank you.

Peter Kelly

And to point out the operating margin, it's pretty terrific.

Ross Seymore - Deutsche Bank

Thank you.

Operator

Thank you. Your next question comes from the line of Craig Hettenbach, Morgan Stanley. Please go ahead.

Craig Hettenbach - Morgan Stanley

Yes. Thank you. I want to touch on just operating margins with the guidance to Q3, you kind of right in the door step of 27%. I know you talked about also continuing to invest for growth. So maybe give us some of the puts and takes in terms of the leverage fall through as well as some of the growth initiatives as you go forward?

Peter Kelly

Our intension is to remain 26% and we have been pretty clear we don't really intent to go beyond that. So to the extent that we get additional revenue which would give you leverage on OpEx will reinvest in R&D further it's a drop of future growth for the company. So you should plan above average industry revenue growth and 26% EBIT below tax rate, fantastic earnings growth.

Rick Clemmer

And generating a lot of cash.

Peter Kelly

Yes.

Rick Clemmer

So I think the key for us is, we would rather be sure that we drive incremental growth as opposed to trends squeeze out an extra 50 basis points on operating income. We think that there is some areas that clearly if we step or improve the investment on R&D side will give us a better long-term growth opportunity. So we have some of those built up as we committed to our investors that it was around 26% operating income. But, our focus is on maintaining the 26% operating income and generating well above industry growth at least 50% faster than the industry growth which we think will generate a lot of operating income and then with the tax position as Peter said a very strong cash flow that can continue to be very efficient for our shareholders.

Craig Hettenbach - Morgan Stanley

Got it. Then is my follow-up speaking to that strong cash flow and the back buy activities been robust in the first half of this year. Can you update us on your thoughts in terms of return of cash in your view on buyback in the context of where the stock is?

Peter Kelly

Well, given our current stock prices it's absolutely the division where we continue to buyback stock.

Craig Hettenbach - Morgan Stanley

Okay. Thanks.

Operator

Thank you. Your question comes from the line of Chris Caso of Susquehanna Financial Group. Please go ahead.

Chris Caso - Susquehanna Financial Group

Thank you. Good morning. The first question is with regard to the bank card business. And in the U.S. that business – U.S. hasn't been a big contributor yet, can you help us to a level set that the size of the opportunity there and how long you think it will take to realize that opportunity? And then maybe the same for China, that is contributing now but is the quarterly run rate that you are experiencing now with the China bank card business a stable run rate going forward or do you expect that to step up over time?

Rick Clemmer

Let's talk about China first, since it's been such a significant contributor of growth over the last year. So I think what we see in China in the – it's kind of a little bit of the best implementation, they have said they will not issue any cards that are not doing interface after the end of 2014 and they will not accept any cards that don't have the protection associated with it after 2015.

So they have accelerated the growth or the implementation in China but probably cutting the overall implementation by at least half. In the case of the U.S., there is not a government dictate or an organization it can drive the implementation for the U.S. So it really comes down to the reduction of fraud and the ability to provide better security. And frankly, part of the problem is the entity that paced the incremental cost about implementing EMV in the U.S. is not necessarily the same entity that gets the benefits of the fraud reduction.

So the overall ecosystem will be much slower to implement in North America but based on some of the issues that we saw late last year and early this year with fraud we see a definite increase in activity. We are very confident that EMV will be rolled out in North America that it would be rolled out over a number of years. It's not something that will be rolled out or implemented on an equivalent basis to what's actually happening in China today.

Chris Caso - Susquehanna Financial Group

Okay. Thank you. And…

Jeff Palmer

Chris, the other thing I would add to Rick's comment is just in the U.S., we see the size of the U.S. C and B market about 1.50 billion cards and it's probably going to be 5 years, 7 years to full penetration of the U.S. very similar to what it took place in Europe. So kind of have to – like I said it's not going to be just a step function over night.

And in China, as we said the opportunity is about 1.5 billion cards, probably 20% penetrated there, but I still think it will take a number of years to get fully penetrated.

Peter Kelly

And even over 5 years, whether it's 5 or 7, it won't be linear nuance, so you won't see like fifth division of first year, you will probably see a lot less than a fifth in the first year, it will be slower and then pick up.

Rick Clemmer

It's really hard for us to project. We provide the technology and the capability and they are going to implement that at their own space about the increased cost that they had to invest on a per card basis for the reduced productivity. So it's hard for us to project, we do see a definite increase in activity. A lot of specifications going out associated with new card implementations, but again, we think that it will transpire over a very extended period of time.

Chris Caso - Susquehanna Financial Group

All right. Thank you. That's helpful. And just move on to the NFC and secured element business and really a question of why that business is defensible. And when investors see growth on [hindsight] (ph) platform there is naturally a fear about the sustainability in that revenue. Can you go into – what about your NFC and secured element business allows you to hold on to the stock once you design those?

Rick Clemmer

Technology, we have to continue as the best technology on the marketplace and continue to win design. As we know couple of years ago, we lost NFC design on a major platform. Fortunately, we are able to win it back in the next platform. So it's about the technology we provide continuing to be in the leadership position and really the benefit that we have in providing the secured element, we are not only a few companies that can provide the secured element, will it be able to provide a total solution basis. And the only semiconductor company that has a software platform with our java card operating system to be able to provide a complete robust solution at a one stop shop.

Chris Caso - Susquehanna Financial Group

Great. Thank you.

Jeff Palmer

Thanks.

Operator

Thank you. Your next question comes from the line of Vijay Rakesh, Sterne, Agee. Please go ahead.

Vijay Rakesh - Sterne, Agee

Hi, guys. Congratulations. Looks like your strongest September quarter guide in five years. I just want to talk a little bit on the automotive side, in the past you talked about design ramps, just want to see what you are seeing in near and mid-term in terms of design wins ramping either it's A dash or [road link exit] (ph)? Thanks.

Rick Clemmer

Well, on the vehicle-to-vehicle implementation Jeff talked about that earlier that will be the first design win that we won, we will not be into 2017 model year which will be shipping in mid to kind of follow up 2016. So we are excited about the design win but as always the case in automotive, you win the design win a number of years, but we actually see significant revenue certainly that took place when we won the door locking solution from the number two U.S. automotive manufacturer. And we are still ramping the models associated with it several years into the process.

So it's not like it's going to create any significant revenue upside certainly not this year nor next year but it's really important for us to establish the foundation in the thought leadership on vehicle-to-vehicle and ensure that by providing a total solution including the security that were uniquely positioned that will really be able to drive that. But, it's not going to be a significant revenue improvement in the next six quarters or so or actually move further than that.

Vijay Rakesh - Sterne, Agee

And just looking at the foundry side, any change in strategy there, are you guys increasing your outsourcing there, any color there? Thanks.

Peter Kelly

No change to our strategy, but we are increasing the number of white good percent to total that we buy externally. So that's just kind of we are managing our growth there.

Rick Clemmer

Yes. But we are rapidly ramping our supply from foundries. We will be at 50% of our total wafer supply in the not too distant future. So going from much lower basis…

Peter Kelly

Few years ago, we were less than 15%. I think we were 30 exit in last year and as Rick said, we look solid and picking up.

Vijay Rakesh - Sterne, Agee

Got it. Thanks.

Jeff Palmer

Great.

Operator

Thank you. Your next question comes from the line of Steve Smigie, Raymond James. Please proceed.

Steve Smigie - Raymond James

Great. Thanks a lot. Just turning back to the using software as part of the security elements/NFC, can you talk about how you guys play in that software side of it in terms of how secured is that.? And then what's the business model for you guys there, how do you get paid for being involved there?

Rick Clemmer

That's a very good question. So on the java card operating system is the something that we have had for well over a decade and investment levels. So this is a key part of our solution in the security space. We have customers that will use their own software on top of our semiconductor platform and we have other customers that will use a solution, our semiconductors as well as our software solution. But, really the key for us is by providing the total solution gives us really the ability to add value for our key customers associated with it. And it's significant investment, it's something that if a competitor wants to really come and pursue it, a number of years never before they could have something that would be equivalent to it. So we think that it's a very key in our defensible barrier associated with our security business, our ID business and being able to position our true leadership position we have there and being able to maintain that.

So it is a critical element. It's one that we continue to increase our investments in that area based on the customer base and being able to provide those solutions. But it is very important to our security business and being able to continue to be a leader.

Steve Smigie - Raymond James

Okay. And then just on the ID business, can you give us some sense of how much ID in the June quarter was core versus emerging and within core roughly the buckets there.

Jeff Palmer

Steve, its Jeff. Core ID was about 85% of total ID in the June quarter. So it doesn't speak for the lot. We don't provide granularity below that on the different sizes of the kind of sub-business lines. We have said that the banking business continues to be the largest portion of ID overall. We have said that our other transaction business is the second largest overall that's showing level of granularity to really go into.

Steve Smigie - Raymond James

Thank you.

Jeff Palmer

Thanks Steve.

Operator

Thank you. Your next question comes from the line of Sujeeva De Silva, Topeka. Please proceed.

Sujeeva De Silva - Topeka

Hi, guys, nice job on the quarter. Just couple of questions on the infrastructure business, the base station area where you have constraints, is that the only area in the business where you are seeing constraints in. When do you expect the constraints to ease, how many quarters? Thanks.

Rick Clemmer

I think you are real careful about talking about of the only area of the business with constraints. I mean clearly as we ramp up our revenue, we are having and Peter talked about the fact, we are having to increase our CapEx investment. So there are other areas where we are limiting back reduction associated with it. The most significant in the near term has been in the area of our HPRF business. And we continue to make investments there trying to improve our customer support. But again, our focus has been on making that a nice profitable growth as opposed to a bombast. And so our additions are somewhat gaited and we have done some of those additions in capacity in conjunction with some of the customer commitments.

So as far as when we'll be caught up, I think that kind of – if we believe what our customers tell us we are still a couple of quarters out from being caught up with the overall demand. We are being concerned back earlier in the year whether it was in double or triple ordering taking place in HPRF and that's one of the reasons that we have been relative stop pulling our capacity additions.

But, we are encouraged about the growth of that business. We are encouraged about the design wins and frankly we are encouraged about the strengthening and some of the relationship with our customers that actually our problems have been able to facilitate associated with it.

Sujeeva De Silva - Topeka

And I have another question on the P&C business, what's the percent the steep versus direct roughly in, what I'm trying to get at is what's the underlying growth you are seeing in the disti part of it, which is a more broad based business? Thanks.

Rick Clemmer

Well, in our P&C business, I think it's about 65% through the distribution channel, it's a little more concentrated than our overall business in total which is more like 50% through the distribution channel and that really has to do with the portfolio. I mean our microcontroller business is clearly more like 80%, 85% through the channel. And so I don't think there is any real significance associated with that other than some of the key smartphone and tablet design wins we are growing most of our microcontroller business is broad based general industrial applications.

Sujeeva De Silva - Topeka

Okay. Thanks guys.

Rick Clemmer

Thanks.

Jeff Palmer

Thanks Suj.

Operator

Thank you. Your next question comes from the line of Jim Covello, Goldman Sachs. Please go ahead.

Jim Covello - Goldman Sachs

Hi, guys. Thanks so much for taking the question. Great job on the report. A lot of questions on I&I that have been very good already and you guys gave some really, really helpful color. Just one very specific question there, have you seen any decrease in the lead times of the longest lead times components yet or they still where they have been over the last couple of quarters?

Rick Clemmer

You mean, as far as we provide lead times to our customers or our own the parts that we secure associated with it?

Jim Covello - Goldman Sachs

I'm sorry, your lead times according to your customers, whatever your longest lead time, if it's a power app, whatever your quote on the longest lead time items to your customers, does that come down at all?

Rick Clemmer

No. It hasn't at all Jim. I mean the truth is, it's not about lead times, it is about allocation of our capacity and working with our customers to be able to meet the requirements. And we still see that for the next couple of quarters with our customer base. We don't see that changing significantly.

Jim Covello - Goldman Sachs

Very helpful. And then just as a follow-up, the growth in the distribution channel inventory, is it – should we take from your last question that the majority of – an understanding that's the preparation for customer ramps in the third quarter. Is the majority of that growth in MCU and Portable & Computing consistent with the question – the answer to the last question, or are there some other areas that contributed to that?

Rick Clemmer

There were some other areas that contributed to that as well, I mean it's basically with the ramp up of design wins that will take place in Q3, it was kind of being in a position to provide that across the board.

Jim Covello - Goldman Sachs

Terrific. Thank you so much. Good luck.

Rick Clemmer

Thanks a lot.

Jeff Palmer

Thanks Jim. Operator, I'm not sure do we have any other participants in the queue at this point?

Operator

At this point there are no further questions in the queue.

Jeff Palmer

Great. So I will turn it back to Rick real quickly for his comments.

Rick Clemmer

Thanks Jeff. First of, we thank all of you for your continued interest in NXP. I think it's important to reiterate the key points and the progress that we have had through 2014. Our revenue growth continues to be robust would grow significantly above our peers. Based on the year-to-date revenue and the mid-point of guidance 2014 is shaping up to be a new high watermark in terms of total revenue with several businesses achieving record revenue levels.

It's also important that we point out an improved profit profile with Q2 profit dollars up about 21% and operating profit dollars up 31% year-on-year. Our strong cash generation, we are able to increase our cash flow 34% year-on-year while spending just over $1 billion on share repurchases over the last 12 months.

So once again, thanks for your support and interest in NXP and we will be talking to you.

Jeff Palmer

Thank you very much for everyone on the call.

Operator

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Good day.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: NXP Semiconductors' (NXPI) CEO Rick Clemmer on Q2 2014 Results - Earnings Call Transcript
This Transcript
All Transcripts