NXP Semiconductors N.V. (NXPI) Earnings Call Transcript & Summary

Why don't we go ahead and get started to welcome everyone to the first fireside chat session of the second day of the conference. It's my distinct pleasure to welcome on stage with me the management team of NXP Semiconductors. To my immediate left is Bill Betz. He's the Executive Vice President and CFO of NXP. And to his left, Jeff Palmer, as you all know, runs Investor Relations for NXP. The format of the session is fairly straightforward. We have 25, 30 minutes to do a fireside chat. I'll start that fireside chat. There is a mic in the middle of the room. And so if you have any burning questions, you need to walk up to the mic because we're not passing it around this year per COVID protocols. But please don't be shy. And with that, Bill, Jeff, first, I want to thank you. It's great to actually be able to host this thing in person once again after a 1-year hiatus. I think both management teams and investors are kind of enjoying the fact that they're seeing and another face to pay. So I really appreciate you guys participating. Bill, I know you guys recently had an Analyst Day, and it was an opportunity for you to kind of introduce yourself to the investment community. I'm going to force you to kind of reintroduce yourself because I think maybe in case anybody in the room wasn't able to listen into the Analyst Day or wasn't there. Can you tell us a little bit about yourself, tell us what your philosophy is as you come into the role of Chief Financial Officer. And I guess importantly, where is there going to be continuity and what on the margin might change as you take over the seat?

Well, thank you, John, and it's great to be here. I think we've been away for 2 years now, not 1 year.

You guys have been away for 2 years, yes.

Yes. Okay. And by the way, thanks for coming.

Thanks, Jeff.

So thanks for coming to our Investor Day also a couple of weeks ago. That was really exciting. And that was actually the first time I saw Jeff for 2 years. But it's good to see our supporters and our owners here. We're very thrilled about the journey of NXP. Related to my background, I've been in the industry for about 22 years, with NXP, about 8.5 of those years. I joined in 2013 and was supporting Jeff. I was the lead of financial planning and analysis. And over time, I expanded my role to sales finance. When we merged with Freescale, I led the integration, the synergies related to that business and then the last couple of years have been really fun because I got to actually oversee the business finance part of it and really go after the execution of the portfolio with our general managers. If I think about the priorities for the CFO role for NXP, it's pretty simple. Our investment thesis is simple. We're in this new phase. It's all about driving profitable, revenue growth. And we talked about these accelerated drivers, and we'll go into more details, I'm sure, with some of the follow-up questions. And then the financial discipline model. We've come a long way. When I joined, we were in the low 20s. Now we're in the low 30s from an operating margin standpoint. A lot of discipline went into that. We finally got where we needed to be. And then we're generating healthy levels of cash. And as you know, from a historical standpoint, we've been returning that cash back through our robust capital allocation policy that we have in place, and we will continue to do so, John.

No, that's a helpful intro. And I guess my typical first question is kind of an open-ended question, and you kind of hit on some of these points as you talked about your background about what do you think the value proposition is for NXP. And I don't want you to relitigate what was a very successful Analyst Day over multiple hours. But if you can maybe condense it down to kind of a 2- to 3-minute sort of summation, especially given how successful the company has been to date. You look at the new strategy and it clearly builds on a very strong foundation, but there are some differences. You took up your growth rate. Your focus areas are a little bit different than they were historically. So I guess, help the room understand what the value proposition is for NXP from here?

Yes, John, absolutely. What excites me about NXP is the people, it's the innovation, and it's the projects and the markets we play in, right? Everything we're doing is making -- especially with our customers, is making things safer, more secure, more connected. And that's in everything we're embedding in our R&D and execution pipeline related to that. And I think to the Analyst Day, that's what it was about. It was trying to get our investors comfortable with our accelerated growth engines. And if you just look back, we talked about 6 of them, and I'm sure we'll go into more details, but big picture, we did about $1.6 billion in 2018, which represented about 17% of our total revenue. Now in 2021, as we end this year, that has doubled to $3 billion to about 28% of our portfolio of total revenue. And we expect that to double again from $3 billion to $6 billion to approximately 38% to 40% of the $15 billion that we laid out to our Analyst Day. And that's what it was about to underpin, to give real examples of how we're going to go do that. And we think that's a significant amount of growth. And then the core part of the business, it's a very good business, right? It's high relative market share. We have lots of things we always talk about on a regular basis and high barriers of entry. I would also say in there, there's things that we haven't disclosed, as they become larger in size, we will disclose them as we go along this journey, but we're super excited and focused on the growth of this company in this next phase of the journey.

As you pointed out, there's a lot of NXP-specific questions I want to get to. I need to kind of get the cycle big picture questions out of the way so we can move on to the more interesting stuff. And I'm sure I'm not the only person that has asked you this question this week or in prior weeks. But we're clearly in one of the strongest cyclical upturns that the industry has ever seen. I think it's getting sort of more pressed than normal because of how much more important semis are to the auto industry. And I think we all probably underestimated how politically connected the auto industry is. And so when they can't get what they want, there's are lot of world governments that try to come to their aid. As the largest supplier into the auto market, it kind of gives you a really interesting vantage point. I'm kind of curious, how are you thinking about the current supply demand situation? There's clearly we're in an environment where demand is vastly outstripping supply. How do you see that coming into normalization? And sort of the big question that you guys always get asked is how do you guard against excess inventory in an environment like this?

Yes. No, that's a loaded question. There's a lot of questions in that one. So let me just try and give the big picture. First of all, we guided Q4, we're sold out, $3 billion. We -- during the Analyst Day, we said 2022 toward the high end of the guidance. And I think one of the important statements that some people picked up, didn't pick up in our Q3 earnings announcement, 50% of our business is exposed to auto like you mentioned related to it. And what we said was, 75% of all our products, all our applications, our solutions are on 52-plus week lead times. So basically, when a customer comes to us today for the auto portfolio, they will not see their product until a year from now. And it's just not auto. It's similar in our other franchises at the same levels. We talked about auto because everybody wants to know what's going on, how can you grow 40% versus on a flat SAAR and so forth. And I thought Kurt did an excellent job breaking that out. But what gives us confidence is we look at several metrics, macro and internal metrics. So we think about the macro metrics, and we just talked about auto, the xEV production. Back in 2018, this represented 7% of total SAAR. Today, I think it's around 17%. And in 2024, it's going to go to 32%. And as we all know, the xEV electrification has doubled the semi content of the traditional ICE. So that's driving a lot of growth there. We look at that, we watch it. The other thing I know we watch is just think about cars and the dealerships in the U.S. I know Jeff, I know you're trying to buy a car for your daughter how long has that taken?

Well, it goes to production in March of next year, if I'm lucky.

Oh, yes. So -- and the other metrics that we look at is, obviously, we look at GDP, but we focus on the good side of GDP. Another metric I like to look at a lot, and it's really with our industrial IoT business. It correlates very nicely with our global PMI. Think about it. Every manufacturing has some sort of semi content going into it, correlates very nicely with that. So we keep a good idea from a macro standpoint. Now internally, 55% of our business goes through distribution, right? Our industrial IoT market, 80% of that business goes through distribution and the auto 40% goes through distribution. We've been at 1.6 months of sales for the last 5 quarters. We've been trying like crazy to increase that, and we can. Now don't get us wrong, we have good visibility on who's pulling that material. And you bet, we're calling them up, our distributors up and say, are they stocking that material? Or is it actually going into manufacturing and then end product? And all our checks and balances continues to go into manufacturing into an end product. So that's something we spend a lot of time by region, by customer. We go through it a lot. The other one, obviously, our own internal inventory, we're in the mid-80s. We want to be in the mid-90s. We don't see that getting back into the mid-90s for quite a while now. So there's no inventory with us. There's no inventory with the channel. As we check the extended supply chain, there's not much inventory there either. And then another one that I think Kurt and Jeff talk about is where they spend their time, 70%, 80%, sometimes 100% of their time is on customer escalations. And we watch this daily, weekly, by technology, by customer, and this is in the thousands, right? Thousands of customers escalating, and we watch this. We're trying to say, oh, we make progress here. Okay, it moves here. I think Jeff talked about it yesterday with one, it's like whac-a-mole, right? In a way of -- it's always changes. It's very dynamic, very complex. But we haven't peaked in a lot of those areas. We still see them escalating. And then lastly, one of our favorites and what the customers are driving is the NCNRs. We didn't even ask. They ask. Supply is becoming so much more strategic to our end customers. And what I can just say, we don't disclose number, but I'd just say it's larger than our long-term commitments.

Several follow-up questions there. And maybe, Jeff, I'll bring you into the conversation because you and I have talked about this quite frequently. Historically, one of the things that we've tried to do on Wall Street, I think you guys have also done internally, just trying to look at your auto business relative to the IHS production numbers. And when we were above that number for a long period of time, we'd say, hey, that delta was content growth. When we were below it, we'd say, hey, there's an inventory burn going on. I think you guys have kind of done a really good job helping us understand that this supply chain is just much more complex than looking at those 2 data points. And so I'm wondering, have you guys come to the conclusion like I think we have that maybe that's not the best way to monitor the health of the business?

Yes. What we tried to do on our last earnings call was you have to actually take a pretty big step back and go, how do we get to where we are today. And if you go back to middle of 2018, it was when we started to see our customers destock in the auto and industrial supply chain. And the metrics we saw was just a lack of interest in being aggressive in bringing new material in and being over their skis in terms of build plans. It was just kind of a mundane period. That continued through the second half of '18, all through '19. And if you go back and read our Q4 '19 earnings transcript call, we said, look, we're feeling like we're finally seeing some green shoots, things are going to turn around, only for us all to go globally into the pandemic. Any excess inventory that was in that supply chain burned off in that first, call it, first quarter, first 120 days of 2020. Against that, you also saw that customers came back late in, I'd say, August, September of 2020 and wanted to place orders on us. And at that point, foundry capacity was pretty much sold up for all the work-from-home opportunities and things like that. So that put us in -- it set us up into the situation where demand far outstripped available supply. So that's one aspect. I think you have to take into consideration is the functional nature of the supply chain over a long period of time. Secondly, and Bill highlighted on this and that is you see some secular trends going on. One, the acceleration of electric vehicles where content is 2x ICE vehicles. Secondly, you see customers start to mix their business towards premium end cars and we see premium cars having about 2x the content. I'll call it, a mid-range car that has a positive. And then thirdly, there's the NXP specific content that started to really emerge in areas like radar, xEV for battery management systems and other areas that started to accelerate. So this is really what's all -- you put all this together and it kind of underpins that blending of our growth above historical Global SAAR.

No, that's helpful. And then, Bill, the other follow-up is just on your ability to grow supply from here on a sequential basis. And a couple of questions here. As if the pandemic weren't bad enough, you also had some weather-related issues that kind of impacted your business. First, it's housekeeping. Are those mostly now all behind you and you've sort of recovered from those weather events, one? And then two, as you look out over the next 2 to 4 quarters, how can you -- what's the pace at which you think you can bring incremental supply on?

Yes. So number one, yes, that's over, right? And that helps us. If you think about the first half of 2021, we were impacted by the Texas winter storm. Now that's fully back ramped up, so we get that full year benefit going into 2022, which will help the supply situation. Your second question, as you can see, over the last 4 or 5 quarters, our long-term commitments continue to rise, right? It started probably 0 and then now it's sitting at $4.4 billion. And it's by -- you can see it by year, right? And so we're making progress. But there's not going to be this one time all of a sudden, bam, $500 billion supply available. It's going to slowly improve. We constantly work this as pockets of capacity come available from other industries that may -- maybe a little bit weaker and we'll go in there and go buy that capacity.

That's helpful. Switching gears to more company-specific drivers. At the Analyst Day, when you laid out the new target model, you like many of your peers assumed in that target model an acceleration in top line growth. I think what might be a little bit different for you guys is some of the bottoms-up product cycle drivers that you can really touch and feel with kind of long, design-in cycles. I'm wondering if you can help walk through and kind of, again, break apart kind of the growth buckets you're looking at. You've got the core business at about 5%, you've got the growth buckets at about 20% to 25%. I think you're -- within the target model, you're looking to find about $4 billion more in revenue over that time period. Help us break down what the drivers of that, from a product cycle perspective?

Sure. So let's start with RADAR. RADAR today is $600 million. This has grown to $1.1 billion in 2024. We are designed in the top 20 of 20 OEMs. We are a leader in the 77 gigahertz in that space. Today, on average, there's one node in the car in 2021. In 2024, it will be 2. In 2027, it will be 3. And beyond that, it will be even 4 or 5 or 6 as we continue to move up. So we're very excited about that business. It's growing at a compound annual growth rate of 20% to 25%. Then if we go to electrification, which is kind of linked to what we're seeing in the xEV market. And this is where we talk about Battery Management Systems. And we are basically in the top 16 of 20 OEMs in that space. And then we introduced the e-motor control of the inverters, which is still kind of small, but it's just starting to grow. And we are in the top 9 of 20 OEM space there. It's an exciting business. It's early innings. That business is $200 million today, growing to over $500 million in 2024. So we're excited about that. Another area that we went into more details, which is much more complex is the car architecture so the processors. And my colleague, Henri talked about this business where I think today, it's around $1.7 billion. We are a market leader with over 30% market share in that business and that's going to grow to $2.3 billion. But what he shared with you is this new platform on 16 fintech called S32. And that part of the business is really early. It's a couple of hundred million today, growing at 25% compound annual growth rate through the cycle to 2024. And really, he go on to talk about the growth after 2024 because that's when it really takes off there. But that's -- we'll get to 5-nanometer, I think we start sampling in 2024.

2024, yes.

That's right.

Bill, if I can just on the domain process, I think, it's a very interesting market for you guys. I'm very curious, given the trials and tribulations that the auto industry has gone through over the last year, are you seeing a stronger drive to actually change that architecture in more models over time because it will help solve their supply chain management problems?

John, I...

or at least alleviate somewhat.

Well, I think, John, it actually, the problem it helps solve is a software life cycle management. If you think about a modern car today, it's almost -- it's a flat architecture with hundreds and hundreds of different microcontrollers and sensors all over the car, connected by wires. And it's a real problem. If you think about all the data that's coming into the car now and being generated within the car, it's really become a bottleneck. And so this move towards domain processing and zonal processing is aimed to address the software life cycle management, enable car OEMs to do over-the-air updates of the software, allow them to do monetization of different types of data within the car. And so I think it's a very exciting area, but it's -- it will take quite a long time before it is a mainstream architecture in auto market. Henri when he talked about it, he felt very constrained in that he said, hey, look, you can only talk about '21 to '24 he said, Jeff, all the excitement happens after '24. The revenue you see in S32 which pretty much doubles between '21 and '24, it's small. It's peanuts compared to what it will be in the decade or so afterwards. I think the other point I'd highlight or add to what Bill said about the different drivers in auto. Remember, in automotive design to revenue cycles are 2 to 3 years. From the time we're awarded a design till we see revenue won, 2 to 3 years. So all these growth drivers Bill just talked about, they're underpinned already with design wins we've already been awarded in the past few years. So in effect, we're asking you to buy a bond on these growth drivers, right? These are pretty much guaranteed, albeit, nothing is guaranteed in life. But it's pretty much already assigned to us.

So you got through radar, you got through with DMS, you got through domain processors. So we've hit the auto end market. What are the other drivers outside of auto?

So let's go to the next big one, which is industrial IoT. This is the secure edge. This is the Wi-Fi attach. This is the analog attach, and this is all about the smart home, the smart factory, the smart devices. This business today, I think, is about $2.3 billion is that correct, Jeff? And this is going to grow very nicely to $3.3 billion with a 9% to 14% type of compound annual growth rate. It's very -- thousands of customers. We demonstrate that we outgrew the market 2x. We'll continue focusing on that. And we demonstrate very nicely. We put a lot of resources in. It's a leading portfolio we have. So very proud of that franchise.

I think the thing I would add, industrial one is that long tail business, tens of thousands of customers, behaves very similarly to automotive. These are very high barriers to entry, long life cycle products that we focus on. And so a lot of the growth that Ron presented at the Analyst Day a couple of weeks ago is actually underpinned already, right?

Next, ultra-wideband.

Yes. Today, it's very small. It's $80 million. Think of this business like the NFC secure mobile wallet, the life cycle of it. It's just taking off now. We're super excited. It's going into the Android phones. We talked about the car access. There's about 5 of those chips that will go into the car and then eventually into the smart home as it opens your front door. But this business is $80 million today, going to be over $500 million in 3 years' time with over 80% compound annual growth rate. We're extremely pleased with that range.

And Bill, I understand the analogy with NFC, but I'm kind of curious to what extent does UWB become just a standardized platform for significantly more applications than perhaps NFC. I think when the average investor thinks about NFC, we think about something that goes into your phone. And then something that goes into some sort of credit card reader for mobile payments. When I think about ultra-wideband, I think there's a lot potentially more applications. I mean I'm hoping in the next 2 to 3 years, when we come to this hotel, we'll be checking in to our room just with our phone, putting up against the door.

I think that the killer app that underwrote the R&D investment, first and foremost, was secure car access, maybe take a quick step back. The interesting thing about ultra-wideband is the intersection of the mobile market, the automotive market and the industrial IoT market. It's really -- it's an ecosystem play. And I think what Bill was trying to allude to about the similarities of mobile wallet is, one thing NXP is very good at is ecosystem development. That's what the whole mobile wallet was about, right? And when you think about how is this going to play out, the first kind of the tip of the spear will be to add ultra-wideband into the mobile phone along with the mobile wallet. That's where the security comes along, right? Then we're going to go and add it into the car. And the car OEMs, like we said earlier, take a little longer to go to production but any auto OEM who's working on an ultra-wideband-based secure access system is working with NXP today, period, end of story. It layers on top of our franchise of low-frequency secure car access. The idea you're talking about, John, about building access, home access, that's kind of the next big kind of killer application we see. But what's been very interesting is all the smaller customers in industrial IoT coming up with really kind of neat ideas of what to use ultra-wideband for. And I mean, we're at that point where you're not sure which ones are going to win and be successful. And so you have to kind of place a lot of bets, but there's hundreds and hundreds of customers working on ideas.

We've gone through 5. I think there's one more here relative to the 5G market and what you're doing in high-performance RF.

RF power, right, focus on the 5G market and the base stations get deployed for 5G. Today, this business is $500 million. We feel very confident we can grow it to $800 million with a 15% compound annual growth rate. So we never -- we don't really share much of that in the past, but we have and we're proud of it. That's where we are investing in the common infrastructure part of the business. But overall, again, these are the growth drivers that will drive the value, the long-term value for NXP as we go forward.

That's helpful, Bill. And then just kind of moving down the target model. We kind of hit on revenue be curious to talk a little bit about gross margin and op margin. You upped the targets on both, but there was some questions at the Analyst Day about your gross margin and sort of the ZIP code you're in. You're clearly above some of your peers, and you're clearly below others of your peers. And so you're kind of a tweener in the gross margin side. So I wonder if you can help us understand kind of the philosophy around balancing profitability with growth? And kind of what is the right sort of landing spot for gross margins over time?

Yes. No, thank you for your question, John. I think, first of all, like you hit it. Every portfolio of every one of our peers is very different. There's no one to one, like maybe competitor A, we overlap 5%, competitor B is 10%. So it's very different across the board. We are very proud of our gross margins. We built the company when we're over $10 billion, we want to be at 55%. Now we're above that. And we think getting to that 58% will be really driven by the new product introductions over time related to it. But to be honest with you, what drives more value to the owners of the company is the top line. A 1% change on the top line is much more greater than a 1% change on the operating margins. It's that simple. And obviously, we want to outgrow the market, and that's why we invest roughly a 16% level. We think that's the right level to invest in. And on the SG&A side, right, we said multiple times that we'll probably -- we think 7% is the right number. But the G&A side of that, we'll probably get some leverage positive...

And the other question you always get around gross margin is just the pricing. And I kind of want to ask this both on a cyclical basis and kind of on a structural basis. You guys have been very clear that you're raising pricing to cover increases in your cost in this inflationary environment, but you're not doing it in a margin-accretive way. First question is, why not? And then longer term, I think the more interesting question, as you think about kind of the roadmap of your products from here, does ASP growth on a mix-adjusted basis, the more capabilities you bring become a bigger component to that revenue CAGR versus units? Or how do you think about units versus ASPs historically versus going forward in the new long-term growth rate model?

So let me answer the first question. If you think about it, right, you're absolutely right. We are not trying to pat our margins. We're not trying to take advantage of our customers. And we think this is the right way for that long-term relationship. No one likes to be taken advantage during times of this -- of these inflationary pressures. And it's actually -- we're starting to see the benefits of it. Customers are coming back to us. They like the win-win approach. They're giving us more business. We're being partners. It's opening up more windows for us as we look at the funnel ahead. So we're excited how that's going so far for the long-term projection of the company. Related to the second question, again, the growth rates that we provided during the Analyst Day were really driven by content, right? If input costs continue to rise, obviously, pricing would continue to go up and we -- that would fall through and be a tailwind. Volumes, like we talked about, we kind of use -- if we think about the auto space, we kind of -- who knows what it's going to be, but we assume the very low volume rate on it.

I want to go back a little bit to the financial impact of trying to grow supply here and really talk about your CapEx and kind of the guidance that you've given. I mean if you look, the long-term target is sitting about 6% to 8% of revenue. You've given guidance for next year that you'll be running above the high end of that. That's not unusual relative to your peer group. I guess my question is, why shouldn't we be concerned about? I mean historically, what you've seen in the semiconductor industry is during good times, CapEx to rev ratios tend to migrate up, which means we're adding supply at perhaps a faster rate than normal. And at some point, that supply comes online, it tends to signal your customers that they don't have to be as aggressive in their ordering pattern. So cyclically, why shouldn't we be worried about that? And I guess what's the durability of this capacity that you're adding?

Sure. Let me first talk about the framework of NXP manufacturing footprint. I think this is important. 58% of the front end, the wafer fabrication, we do externally. We have the foundry partners. You see that in the long-term obligations. So that supply is improving. That's what gives us confidence that we can deliver to the high-end revenue rates that we've given. And then if we turn to the back end, about 75% to 80% of what we do on the back end is internal. This is where that capacity -- majority of that capacity is being added so that we can support the higher revenue. And we are putting in a little bit more capacity to make sure we can grow -- outgrow the market. And that's where you see this big blip in 2022, and we feel very confident this goes back to more of between that 6% to 8% in the outer years. And you remember, these are long lead times. These are orders that we had to put in place already, several months ago, to be able to have that capacity in place, and that's what gives us more confidence why we gave soft guide, I guess, you call it to the high end of the model.

And the useful life of this capacity once you put it in?

Oh, we're finding the useful life of all these capacities lasting longer than ever, 10 years.

Last question I have, it's a relative softball, but it's a good question about cash return to your investors. You guys have done a fantastic job. Remind us again kind of what the parameters are you looking at. And I think one of the things that people perhaps have missed in the target model you gave out at the Analyst Day is, you're going to have $10 billion to $13 billion of sort of free cash flow to get back to investors within the target model, which is sitting around 15% to 20% of current market cap, which is not an insignificant amount of money.

Yes, absolutely. No change to our robust capital allocation strategy. We believe we found the right balance. We like that. That provides financial discipline to the company, provides tax benefits for the company. And we think that's the right level. It's worked. We returned $7 billion in the last 3 years to our owners. And we're going to continue to do so as we generate healthy levels of cash, we are going to reinvest in the business, but that still leaves a sizeable amount of cash, which we described of that $10 billion to $13 billion that we have no problems giving back to our investors through a combination of buybacks and cash dividends.

Great. With that, I think we've ended our time in this session, but I want to thank everyone for joining us this morning, but especially for Bill and Jeff for spending time with us. Great conversation. Really appreciate it.

Thanks, John.

Thank you.

Appreciate it.