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

Great. Welcome back. Joe Moore. Happy to have with us today from NXP, Bill Betz, CFO; and Jeff Palmer from Investor Relations. Thanks for coming.

Maybe we could start with just an overview of kind of current industry conditions. It's clearly really been a tough 2-year stretch for your customers to get components. It's been pretty tight. Supply chain with a bunch of idiosyncratic disruptions. When you reported, you talked about backlog that takes you through this year and people, if you let them, will be looking into next year. Can you talk about that level of visibility? And do you think we might see a more calm supply chain going forward?

Yes, absolutely, Joe. First, thanks for having us. Great to see our owners in the audience here and the supporters of NXP. But before we get started, I just want to say on behalf of the company, we are shocked and saddened by what's going on with Russia and Ukraine crisis, and our hearts and prayers do go out to our team members, family members and friends and all human life. And we hope and pray for peace and stability. So let me talk about the Russia -- Russia and Ukraine crisis real quick. We've been getting the question directly, what type of impacts do you have? And really, from a people wise, we do have 100 engineers that are based out of Russia. And from a revenue standpoint, last year, we serviced about $25 million for the full year into -- through our distribution partners into Russia. So that's the direct exposure we have. From an indirect standpoint, we've been talking about and you've been hearing about neon and palladium and so forth. But what's going on right now with indirect is our car OEM manufacturing related to the wire harnesses in Ukraine, they are shut down, paused for a couple of weeks as they go and get that second source. Now going back to your supply conditions, everything else, what's going on. Just to remind everyone, as we mentioned, and it was part of our guidance, we were shut down for 10 days in our Tianjin factory, assembly and test that we do there, impacted us by about $50 million. That was included in our guidance. I'm very pleased that has been back up and running, and we should see that $50 million worth of supply come back in Q2. Second is a metric that we started sharing 2 quarters ago about what our lead times to where our customers are. And that time, about 70% of our entire portfolio was on 52-week lead times. That has actually increased to now 80% across our entire portfolio of autos, industrial, comm and mobile. And clearly, our NCNRs are much greater in size. We can't supply them all, and we're basically sold out for the year. And I mean 2022 is going to be a difficult year, Joe. We'll see what happens in 2023.

And on that note of nickel -- or neon and palladium, it seems like everybody we've talked to has kind of the same response that it doesn't seem like a big issue. But then I hear Tier 1 auto suppliers, who one talking this morning and saying, and they do think it's going to be an issue. So to some degree, it's kind of self-fulfilling in terms of remaining in this 52-week lead time environment. It's just another idiosyncratic potential disruption that we're facing.

Yes. So first, let's talk about neon real quick. For us, specifically in NXP, our sourcing of neon does not come from Ukraine. And we typically hold 6 to 9 months' worth of that -- of neon, right. So really, in the short term, no impact, but this is something that we are continuing to monitor very carefully, and we will adjust accordingly as we go forward.

And then can you talk about where the supply constraints are that you have? Obviously, there are some components that are -- that you have a shortage of, there's also components where your customers have a shortage of something else and that probably affects timing and things like that. How much of what you ship do you think where you might be the bottleneck or you might be the binding constraint on your customers' business?

Yes. As you know, Joe, the semiconducting supply chain is super, super complex. We're talking -- just let's think about the car, thousands of semiconducting go into a car and having that all lined up perfectly is very difficult to do in normal times, which tend to be 3 to 6 months, and those obviously have been extended. As the industry is running maxed out manufacturing close to 100% across the industry, any little, I'd say, again, hiccup that occurs, you'll feel it. I mean I think last week, as an example, Taiwan lost half their power for a couple of hours. Clearly, that was an impact and now we'll recover from that impact as we have a factory there and our suppliers are there. But still you feel every little thing nowadays, because it's so tight across the board. There's basically just no inventory, I would say. And again, everything we're shipping today, we're shipping hand to mouth. We think 2022, the supply will continue to improve over each quarter as we go forward, and that's why we felt very comfortable to say that we'll grow higher than the high end of our long-term guidance of 12% in 2022.

And supply will improve, meaning you'll have more supply, not necessarily the...

Correct.

Your supply-demand balance will improve.

No. Incrementally will be better is the way to think of it.

That makes sense. And then on that long-term growth, I mean you talked about 8% to 12% CAGR through 2024. That's actually not a number that you guys have been at historically until recently. Can you just talk a little bit about what gives you -- and we will get into some of the Idiosyncratic product driver type things. But I guess what prompted you to kind of give a little bit more of an aggressive forecast going forward?

Yes. So big picture, first of all, we're very pleased with the investments we've made over the last 3 or 4 years. Finally, I would say our merger with Freescale is paying. We plan to grow. Just specifically, if we talk during Analyst Day, we shared about the 6 specific, company-specific accelerate growth drivers. And if we just look back, those 6 areas were about $1.6 billion in 2018, and that's going to grow or it has grown to over $3 billion exiting 2021, which represented about, I think, roughly 28% of our total revenues. Now we expect that $3 billion to double to $6 billion, which will be about 38% of our revenues in 2024, and we feel very confident with our design win traction driving there of everything we see, we feel confident hitting those numbers in these specific areas. And then lastly, you have what we said the remaining part of the portfolio, which is very good, relative high market share that we have and that we just said it's going to grow within semi market around 5%, but we believe we'll also have a good chance of doing even better than that. So overall, we feel very pleased with our growth projections that we provided.

Yes. Maybe, Joe, I'll just add in. And you said you started the question with, well, what gives us the confidence. And really, if you really could go back to 2016 and '17, when we were integrating the Freescale asset together and we put together our road maps, we laid out a road map of new product areas we wanted to be leaders in. And it takes time for R&D work to get done, a couple of years. And if you just look at where we are at today versus 2018, a lot of those initiatives are starting to pay off quite nicely.

Well we'll dig into some of those drivers, maybe first looking at some of the end markets, automotive semis grew about 40% last year, not just for you, but for everybody. You grew a little faster and automotive production was down. There's a lot of ways you can connect the dots, and we've sort of articulated that we think we still grow 20% plus this year, and we think last year wasn't as far apart as those numbers, I think. But how do you guys reconcile that really strong automotive component growth versus automotive production, which was down in unit terms?

Yes. About 2 quarters ago, we grew 44%. And I think, Kurt, our CEO, did a really nice job breaking out the components of why we grew 44%. And you have to really go back to 2018 and look at what occurred, what we shipped in and how the supply chain itself got leaned out. We had the trade wars in 2019. In 2020, obviously, COVID hit. So with all buffers being basically leading to no buffers after COVID, a lot of it was driven by volume of content along with that. So I'd say there's about 3 areas of content growth. You got the EV content, which is double the semi content over your traditional ICEs. You have the premium cars take place as OEMs optimize their mix and profitability. And then you have the company-specific drivers, and we talked about 3 of them, specifically during Analyst Day, which are radar, S32 platform as well as our BMS set of products related to it. And then we also mentioned price. But price was the smallest out of all those components that I just talked about. But -- and again, related to auto segment, we haven't guided that for the full year, but IHS has 9%, 10%, then you add the content related to it. And then we do believe pricing will play a bigger component compared to 2021. So overall, we feel very comfortable with our growth projections.

And then the role of inventory in all of that, work-in-process clearly went up last year for the automakers, because they couldn't get certain things. How much of that is semis, we're not really sure. But I guess when the dust settles from all this, and we get past these shortages, what do you think the automotive customers, both Tier 1s and OEMs are going to do? Because it seems like they'd be likely to build fairly large amounts of buffer inventory to make sure that this won't happen again. Do you foresee that? Are people telling you that they want to do that? Is there any chance people are doing that already? It seems less likely given the production shortfalls that they're having. But won't there be a concerted effort to put that raw materials into place?

Yes. I mean we think getting customers and our extended supply chain will have to hold more inventory in the future with so much destruction that occurred. I think over $200 billion were lost by the OEMs when they did not hold this inventory. And you have to think about the value of the semi inventory they're holding is not worth that much of the total complete BOM. So we expect them to hold more related to it. And I'd say, Jeff, I don't know if you want to add anything else to that?

I'd say the -- if you look at our cycle times, which are in best case, best times 3 to 6 months. And so we are hearing the OEMs and the Tier 1s saying, look, we'd like to probably hold somewhere between that 3 to 6 months. But we've been very clear with them and we've been very clear with investors, that won't be on our balance sheet. And we don't think you even get to a point where you can even start to action, building up strategic inventory until sometime in '23.

Yes. I mean the dust has to settle from everything that's going on.

Yes. I mean at this point, the demand signal is far in excess of supply, and we don't see anything in 2022 that paints a different picture. So sometime in '23, knock on wood, maybe you get to equilibrium, and then you might be able to talk about building strategic inventory.

Great. So then in terms of the 3 growth drivers you mentioned, radar and batteries are sort of intuitive, why those would be growing quickly. The processor line and the growth in the S32 and the growth that you guys have been seeing there is probably less intuitive for people, given that that's already a market that exists. Can you just talk a little bit about the proliferation of MCUs in the car and both from the dollar content and unit content?

Yes. I think what you have to think about, Joe, is right now today in the average car, the architecture of the car is a flat point-to-point type of system. And what's happening is you're seeing more and more data come into the car, more and more data generated in the car, and it's choking that network. Then if you think about the lines of code for the operating system of the car, it can be up to 2 million lines of code. That's continuing to expand. So what the auto OEMs want to do, and this is not something they just decided to do this year. This has been going on since probably '15 or '16. They want to create some hierarchy in the car and partition the car into specific -- where you would have a, what we call a domain processor, and think of that as not as a microcontroller, but a multicore MPU that will control all the leaf nodes in a domain below it. And that domain processor -- we've been able to identify about 5 of them. And they will talk again to each other against a high-speed gigabit Ethernet backbone to almost a network gateway type of a device. And so in this way, you'll be able to create some partitioning hierarchy into the car. And that's a brand-new opportunity for us. It creates brand new socket opportunities, brand-new design opportunities. That business for S32 today is already about $300 million worth of business, and we expect that to grow at least to about $600 million by 2024, and actually accelerate quite dramatically beyond that. And so why is that? It's not only this hierarchy that's being built, but as cars become more and more complex, and more and more features added to cars, this is the only way you can really get your arms around it. Very analogous to what happened in the building network industry 20 years ago.

Okay. And then maybe if you could similarly talk about radar in terms of where you see that growth coming from? I think you've talked about $600 million going to $1.1 billion. Is that just from sort of higher usage of radar and how much of that is sort of Level 2 plus features that have to get added in to get to that level?

Think about the radar driver as kind of a multiplicative, a 3-way multiplicative effect. Every year, there's more cars with radar. There are more nodes per car and there's more semiconductor complexity in each of those nodes. Each of those, steps those multiplicative steps benefits us from a revenue perspective. Today, there's probably on average, probably about 1 radar node per car. Next couple of years, you might get to about 2. We have design wins in the pipeline that show up to 5 and 6 nodes per car. And each note, when we talk about the term of a radar node, it's a transceiver that an RF signal goes out of and comes back into, that's connected to a processor that processes that information and then it takes action somewhere else in the car. So that each of those nodes is a fairly good chunk of ASP for us.

Okay. And then...

And just one point I want to add, Joe, is why does anybody want a car with radar? What makes that unique? You see standards around the world like in Europe the NCAP standard, where for features like automatic emergency braking, automatic lane departure warning, where the ability to fulfill those requirements is fulfilled with a combination of both radar and camera, not one or the other, but both.

Yes. I mean I think you see that even today with adaptive cruise control and things like that, radar plays a big role.

Exactly. So I mean, consumers want safer cars and they're willing to pay for it.

And then within the Power Control battery management portion, $200 million now going to $500 million. Obviously, that's a big inflection that's coming. NXP's role in that, can you talk a little bit to the investments you've made?

If you think about the xEV powertrains, their line is kind of 2 gross level parts. There's the part that moves stored battery power to the electric motor. That's fulfilled by power discretes, something like Infineon, ST, others, we're not in that part of the powertrain. But the other part of the power, which is the control of that system is where we're focused. And battery management systems is an area that we brought to market a unique solution. It's also, again, a system solution, multiple chips. It's an analog component that sits out on the battery pack itself. We connect all those precision analog devices to a back-end processor where we run load balancing software that manages the charging and discharging of the battery pack that monitors the health of every cell in the battery pack. And it's a different solution than our largest competitor, and it's really resonated well with customers. And so from basically 0 in 2018, that business is roughly $200 million today.

And those are applications in both hybrid and your battery?

Yes, across. And our content, it's a scalable solution. So if it's a pure EV 800-volt car like a Porsche Taycan, our content is very high, right? So it does scale with the density of the battery pack.

Okay. Great. So that was the main growth drivers in automotive, which is about half of the company. Maybe if you could talk a little to some of the other segments starting with industrial IoT, 22% of your revenues. Can you talk about some of the growth drivers there?

Yes. So Industrial IoT doesn't have a nice and neat story, if you will, as automotive does. It is a very long-tail business. Tens of thousands of customers, no 1 customer, no 1 product type makes up more than a few points of revenue. We focus on things like industrial automation, home automation, smart buildings, wearables, type of things like that. And our whole focus there is about bringing a complete solution to our customers. It starts with having one of the broadest portfolios of industrial application, microcontrollers, starting from application processors, crossovers and embedded MCUs. That's kind of -- that's the first point you win. Then you complement that with analog attach, complement that with different either narrowband or wideband connectivity, and we have options for customers whether we can either embed security in the processor or offer it as a discrete device. We bring to the customer those -- all those pieces, if you will, almost a reference design with a firmware already bundled around it. So customers can pick that up and move quickly time to market. And we try to focus on scalable solutions. So if you adopt, let's say, a product at a very high performance point and you want to scale that down, we have 10 compatible processors that allow you to do that.

Great. Okay. And then in mobile, your focus is on the ultra-wideband piece, which we've written a little bit about. Can you give us a little bit of an overview of the growth drivers there?

In mobile, we're a niche player. Let's just be real frank about that. We focus on a very specific part of the mobile marketplace, and that's what we call secure mobile wallets. So if you've used your phone to buy anything either through the iOS or the Android operating system, you've probably used our technology. And that's been the primary driver of that business for a number of years. We've introduced something known as ultra-wideband, which is really -- it's been around for some time. But what we're trying to do is create a virtual key, if you will, just like we've created a virtual wallet in your phone, we're creating a virtual key in your phone. And it basically complements the ultra-wideband device, complements our embedded secure element technology. So it's an intersection of mobile, automotive and industrial and IoT. First couple of years, it will be primarily a mobile business as you seed the market and then you'll start to see automotive companies introduce their secure car access solutions based on ultra-wideband in the years coming forward. Our business today is primarily in the Android marketplace on the mobile side of the world. In the car side of the world, we are the market leader of secure car access solutions already. So every car OEM, who is planning on fielding an ultra-wideband based solutions working with NXP, but their design to revenue cycle can be 2 to 3 years, whereas in mobile, it can be 12 to 18 months. So you'll see automotive phase in later in the cycle in that '21 to '24 horizon.

Okay. Great. So I do have some financial questions I want to ask, but maybe first, I'll pause and see if there's any questions from the audience.

Given that you touched on so many different end markets, whether it's industrial, auto, et cetera, et cetera. Can you help us understand which of these following markets you expect the bottleneck in chips to alleviate the soonest, EVs, ICE, solar, distributed power and kind of general industrial?

I think what you have to think about is how we determine where we source products from. If a product requires a process node below 90 nanometers, we source that externally. So our workhorse process nodes are 55, 40, 28. We're just starting to ramp a 16-nanometer product. And as Bill said earlier, the long pole in the tent currently on the supply-demand environment is finished wafers. And so it's really not a matter of any one end market that the bottleneck alleviates first. It's -- basically, we're oversubscribed across all product categories. So our #1 goal right now is to ensure that our customers don't go [ lying ] down. And so we're constantly jiggling demand from customers versus available supply.

So how do you manage that allocation process? I mean, are you trying to keep everyone equally angry with you or...

Yes. That's a good way of putting it. I am glad you're so confident. Yes. Yes.

I mean it seems because the guys like automotive, there's a higher multiplier, right? There's a lot more revenue that they lose for lack of parts.

True, but I think we don't want to be the determination of who is a winner or loser in the marketplace. What we want to do is make sure that we are not the company who shows up on the front page of the Wall Street Journal as why, you pick your auto OEM, can't build the product.

They're here tomorrow, but -- all right. Other questions from the audience? Maybe then if you could talk a little bit about gross margin. You've sort of described that as being mix driven from here on the gross margin improvement. I guess, the cyclical drivers of gross margin are probably pretty optimized when you're running like this. And I know you want the message being to customers, you're not raising price to get more margin, you're just passing along cost increases. But how do you think about that generally? Because these cyclical conditions should still be good for gross margin, I would think.

Yes, absolutely, Joe. The way to think about it, our previous model was about, I think, 53% to 57% and now we're 55% to 58%. We're running at 57%. We believe that's the right ZIP code, call it, for the rest of the year, plus or minus the mix. But we did -- there are levers, right? And we experienced that by beating our guide by 80 basis points. Our utilization, which we never thought we could get there, actually did 97% internally compared to 95% the quarter before. So could we squeeze out another point? We're trying to and improve our throughput. Another area, obviously, is the incremental revenue that you get, you do get some fall through over your fixed costs, so that can help you 10 basis points here and there. And then finally, like you said, mix does play a role and it's all about your new product introductions and growing that revenue, which is higher than the corporate average. So we drive something internally, looking out 2, 3, 4 years related to entitlement margins for our businesses, and that's the designs we win today obviously yield those margins where we want to be in the future. So we're super excited about eventually hitting that target of 58%.

Okay. But when I think about the mix-related improvement, I mean, the -- it's not like there's any obvious low gross margin part of your legacy revenue either, right?

Unfortunately, mix, we're shipping hand-to-mouth in this environment. We're not trying to optimize mix in any way. We're trying to prevent our customers from being [ lying ] down. So that's why we talk about it could be plus or minus. Our first priority is our customer during these times.

But the mix going forward is that you'll have these products where you have a little bit more maybe of a leadership role you get higher margin?

Absolutely. And think about over the long haul, we should be getting to that 58%.

I think what's important to kind of contemplate Joe, is if you go back a number of years, post the merger with Freescale, we made a very concerted decision that any new product that we would greenlight for R&D investment had to be accretive to corporate margins. Now given the cycle of R&D, it takes time for those products to come out and it takes time to win the designs. That hurdle rate continues to grow. We don't greenlight any new products that are not accretive to corporate margins.

Great. And then my last question, capital allocation. I know you just increased the buyback authorization recently. You've generally been increasing the dividend, but you've also been paying down debt. So how do you think about the trade-offs there? And where do you see the use of cash going forward?

Yes, Joe, thanks. So no change in our capital allocation strategy. We'll continue to invest in the business and outgrow and set us up to outgrow the market and our peers, I would say. We have a great business and financial strategy that drives excess free cash flow that we like to return back to our owners. Last year alone, we returned $4.6 billion, close to 200% of our excess free cash flow back to the owners of this company. As we talked about during Analyst Day, we said we'll return about 100% of our excess free cash flow back to the owners of the company, and that ranged basically from year 2022 to 2024, our objective is to return back $10 billion to $13 billion back to the investors. And then bringing on debt, as you know, we retired our last year in November, our 2022s, and we extended the maturity of our debt and our weighted average cost of our debt is around [ 3.7 ]. So we're very pleased with that, and we'll continue to execute to our capital allocation strategy.

Great. We'll wrap it up there. Thank you very much.

Thank you, Joe.

Great. Thanks, Joe. Thank you, everyone.