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

Welcome to the NASDAQ partnership with Jefferies and the London Investors Conference. We'll now go live to London.

In London in these fantastic offices of Jefferies. Here for our 48th -- wow, incredible to say that, 48th Investor Conference held in partnership with Jefferies and the NASDAQ Investor Conference is really built to show our company's dedication to growth and the advancement of companies and investors in our community. As we say at NASDAQ, our work with clients does not end on the listing day. It extends well beyond day 1 and we hope to celebrate many more milestones to come with them and to work with them as they are public companies. This is one of the ways that we work with our companies. I think for all of you investors in the room, you clearly want to hear from me quickly at NASDAQ about what we're seeing in the market and we're certainly here at the midpoint of 2023 with a very light IPO market, but I think that investors at least stateside are cautiously optimistic about the second half of the year as the markets have certainly continued to perform exceedingly well over the past few weeks. And in terms of IPO activity, we certainly anticipate some very well-known recognizable brands to list on NASDAQ later this year. Many companies have updated their time lines with us and given us their current market conditions. Given the current market conditions, they certainly are interested in this window. And we think that the post Labor Day U.S. to Thanksgiving window could be fairly busy. There's certainly a lot of talk about and we're excited to have this opportunity to create meaningful dialogue today between NASDAQ-listed companies and the investor community. This year, we welcomed 20 top tech companies to the conference, 9 of which are part of the prestigious NASDAQ 100. We're joined by the likes of companies at the forefront of technology like Microsoft, Bumble, Analog, Cognizant and NXP, just to mention a few. I'm also pleased to say that we're joined by nearly 150 investment professionals from 100 institutions in the U.K., France, Switzerland, Scandinavia, Germany and Spain. On behalf of NASDAQ, I'd like to thank all of you for joining us today and for the extraordinary work that you've done over these challenging years. Please do not hesitate to come and talk to myself, my colleague, David Wicks at the back of the room, Laura Hillgren or anyone on the NASDAQ team. We really feel like all that we do is based upon the feedback that we get from the investor community, and we want to make sure that we continue to provide forms like this to meet your needs. Before we kick off today, I'd like to introduce Janet Harbison from Jefferies, who also wants to say a few words. We appreciate your attendance today. Please enjoy the conference.

Hi. Morning, everyone, and welcome to our NASDAQ conference in partnership with Jefferies. I just wanted to echo much of what Bob said, we're really grateful that you made the effort to be here with us in person. And I also wanted to say a special thanks to Laura on Bob's team and Abby on the Jefferies team for all of their hard work putting the event over the next couple of days together. And there are a couple of things that I wanted to mention tomorrow, one which isn't on the agenda, which is that ahead of the fireside chat with the CFO of NVIDIA, and Mark Pappas is going to do a deep dive on NVIDIA in this room starting at 3:45 p.m. And that's not on the schedule, but we will e-mail you all to let you know. I also just wanted to mention U.S. institutional investor. This is a survey that's important to Jefferies and Mark, our semis analyst is one of the analysts that we would really appreciate votes for it in this survey. It takes very little time, but a 5-star vote for our analyst makes all the difference. Our tech team from Jefferies is Mark, Brent Thill, George Notter and Samad Samana and a couple of those, you're going to see doing fireside chats over the next couple of days. And if you need any help on how to get to the link to speak to your Jefferies sales representative. And with that, I want to hand over to NXP and Mark, and Kurt Sievers, the CEO; and Bill Betz, the CFO, and enjoy your day. Thanks so much, everyone.

Okay. Great. Well, it's my privilege to kick off the fireside chat today, and it's my honor to have NXP, Kurt Sievers and Bill Betz. Kurt Sievers is the President and CEO of NXP. He joined the company in 1995, so a 28-year veteran of the company, if my math is correct, okay. But he started when he was 13 years old there. So he's not as old as the time may imply. He's been a member of the executive management team since 2009 and 2015. He played a key role in the merger of NXP with Freescale and has served as the President and CEO of NXP since May of 2020. Bill Betz is the Executive Vice President and CFO of NXP. He has more than 20 years of financial experience in the semi-conductor industry. He has held several financial leadership positions with Fairchild, LSI and Agere. So I'm going to do -- host a fireside chat with some questions. And hopefully, if you guys have questions, we'll hopefully try to work them into the lineup at the end of the Q&A. So let's get started. Kurt and Bill, welcome. Thank you for joining today.

Thanks, Mark.

Thank you, Mark.

Great. So maybe just to start off at the highest level. Over the past 10 years, there has been a lot of consolidation in the microcontroller industry, including your own acquisition of Freescale, now 6 companies account for 80% of the industry. Many investors consider this an elite group of highly profitable companies with healthy growth and exposure to end markets with great secular growth drivers like automotive and great returners of capital to shareholders. How would you suggest investors think about NXP relative to other high-quality companies in this elite group?

Yes. Thanks, Mark. I would actually say our -- clearly, our main focus for microcontrollers is in automotive and industrial, which is also the 2 key revenue segments from a growth perspective for the company. We guided both segments with 9% to 14%, actually even ahead of the corporate average and microcontrollers are a core part of that. Now I would somewhat change the language you used because from our perspective, there is a blurring line to the use of microprocessors. Especially in automotive, the compute requirements are so much going up that a good part of the compute power in a car going forward is actually not just microcontrollers, but increasingly microprocessors. And we even invented the category, which is kind of in between, which we call crossover, which has the real-time requirements of -- or performance of microcontrollers plus the media performance of microprocessors. So if you put the 2 together, we are the #1 today in automotive. Actually, just ahead of our Japanese competitor, which is also doing a very, very good job. Now our opportunity going forward clearly lies in the fact that we are leading both on the microprocessor and the microcontroller side because again it's going to shift up -- to be more specific, we are today shipping in volume, 16-nanometer devices, which are all microprocessors. No embedded nonvolatile memory anymore. So there's really breaking with the credo of the past of what you have to do in terms of compute in the car. And I'm proud to say that it is this month, June 23, that we are taping out our first 5-nanometer part, which is a very powerful vehicle computer, a microprocessor for the car. Now I say that because you asked for the competitive dynamics, in my view, this will help us to leave the traditional microcontroller suppliers behind us because they will not be able, we think to follow that move to microprocessors. But of course, at the same time, we face new competition, which is then microprocessor companies entering automotive. And you know the names. We just talked about one being here apparently this afternoon.

Right. Great. All right. Well, that's a key distinction. I think it's not really that well understood so thanks for that. And when we talk about M&A, you acquired Freescale at the end of 2015. I think a lot of investors when they hear of M&A, they sometimes wonder what the value add has been and after all is said and done, how do you track and measure the success of that. What's the most tangible evidence on the product side that has come from merging of the companies that you can point to that? Makes the case that it has been a success?

Yes. First of all, across the whole company, it is indeed that we could add embedded control capability, which is what I just said earlier about microcontrollers and microprocessors, which we had a little bit in the old NXP, but most of that came actually from Freescale. Very tangibly about revenue synergies, I would use Radar. We were merging the Radar capabilities from Freescale, which were about silicon germanium and processors. And in NXP, we had a 40-nanometer CMOS 77 gigahertz Radar development, which was an ideal complement. And it's good to see that, that made us now the #1 in automotive radar worldwide. And very specifically, we guided in our last Analyst Day, the radar business to become $1.1 billion next year, which is a pretty sizable number for just one segment. And it's good to see that we are very much on track to hit that $1.1 billion in Radar next year. So #1 position, clear result from Freescale and NXP combination. The other one is battery management, which is all about range extension of battery electric vehicles, which clearly was also a combination because the Analog high-precision capability for this came from the former NXP. And again, the microcontroller in the battery management system came from Freescale. And that's today our big differentiator to our competitors in battery management, which either offer only a microcontroller or only the Analog front-end chips. Now we have the combination. So we have a system offering for battery management, which is a sheer result of the combination of NXP and Freescale. Here, it's even better and Bill loves that we gave a $400 million revenue forecast for that business to be hit in '24. It's really embryonic thing, which just started a few years ago. Now we hit the $400 million already last year and it's not going to decline into next year. So that's more than on track, clearly a result of the massive penetration of electric vehicles, which we are writing here with a superior system solution.

Great. Those are great concrete examples. I want to talk a little bit or ask you about the profitability because it has been on an upward trajectory for the company. After you divested the discrete business in early '17, your margins were in the 53% range. They took a dip in the low 50s when COVID hit in '20, then they jumped 500 basis points in '21 to 56%. And since then, you reported full year of 2022, just under 58% and this last quarter, you reported 58.2% and guiding again for 58.2% on this upcoming quarter on lower utilization. What are the biggest drivers here? And can you talk about how utilization and price and mix factor into this?

Sure, Mark, absolutely. So to look back, really, the company was always scaled to be about $10 billion plus when we merged with Freescale and that was to get us to that magic number of 55%. From 55% to 58% was some utilization, optimization of mix, NPI throughput but most importantly, over the last 10 years, what we've done with the fixed cost structure of the company, has reduced it. So today, the fixed cost of all our manufacturing combined together is only 30% fixed and 70% variable. 10 years ago, it was swapped the other way around. So we get the question a lot and says, okay, now you're at 58%, like you mentioned, you're running your utilizations in the mid-70s. So what keeps you confident staying at 58%? And the way you have to look at it is that our utilization in the mid-70s is being offset by our favorable mix optimization. In Q1, if you think about our distribution revenue was only 48%. Distribution tends to have a higher margin because you're servicing lower-volume customers. We expect that to improve, to offset this current headwind of the utilizations in the mid-70s. Now where is the sweet spot for utilizations? And again, this represents 40% of what we serve internally, where 2/3 of it is linked to auto and industrial for that capacity internally at 90-nanometer and above. And with that, we believe that it will become a tailwind. The sweet spot is about 80%, 85%, when you're running too high, it costs more. You have over time. The throughput is not good. So if I step back, 58% is just -- we feel very confident there but we're not going to stop. We're going to continue to move the gross margin higher and the levers that we have is utilization in the short term, our mix optimization in the short term but more importantly, longer term, it's the new product introductions that we continue to introduce. Everything that we invest today has to drive an entitlement gross margin of greater than the corporate average. So again, today, we're investing in 3 to 5 years when that revenue comes to be. Think about products that are driving superior gross margin of 58% or above.

And just to go one layer into the weeds here. How does -- the biggest question I received from investors was how does the gross margin stay flat on lower utilization?

Sure.

Can you just [ populate ] the variance for us?

Sure. No problem. So again, running in the mid-70s is a headwind. We are running the sweet spot to 80%. What's offsetting that is the distribution revenue that we expect to improve off of Q1, which was really low, 48%, it tends to run in the mid-50s. So those 2 are offsetting each other in the short to medium term. And then after that, it will be the new product introductions, the utilization is going back to the mid-80s. Part reason why the utilizations are in the mid-70s mark is because we're re-purposing the factories today. We run out of space. So what we're doing is we're outsourcing all that bulk CMOS, creates more room for us internally. And of the 8% CapEx we're spending, 75% of that CapEx is going back into the front end, so we optimize our internal IP proprietary technologies. So it's balancing right now. But after that, as we perform, it's the normal block and tackle and which will grind gross margins higher.

Got you. Okay. And then your revenues have grown 50% over the last 2 years. What percent of that is pricing versus TAM expansion?

Well. We clearly labeled pricing. For the calendar year '21, pricing was 2%. For the calendar year '22, pricing was 14% and that's really the total corporate pricing. And we will increase price again this year. I can't give you the number yet for calendar '23 because it's pretty dynamic since the policy has been and continues to be that we are offsetting all the input cost increase, by price increases plus margin in order to keep our gross profit percentage, so the 58% currently, which Bill was speaking about to keep that whole. Since input costs, unfortunately, I would say, continues to go up. Also this year, we will again increase price this year.

Got you.

But now all of that, by the way, has made us grow market share against the TAM quite substantially. Now I don't want to overdo it in terms of calling us heroes on this. It is because we have a superior exposure to automotive and industrial. And the matter of the fact is that through the past 2, 3 years, and if you believe any market research, also the next 5 to 10 years, automotive and industrial will be the fastest-growing subsegments of the total semiconductor market. Now for NXP, this is 70-plus percent of our business. So we naturally grow market share against TAM just because of that portfolio exposure.

Got you. Let's shift over, you brought up automotive, let's kind of do a little drill down there. During the 3 quarters before COVID hit, NXP was averaging about $1.1 billion in quarterly revenues in the automotive business. Last year, at this conference, on this stage, I observed, you printed 3 $1.6 billion quarters in a row. And I wondered whether it would mean revert and you made the case for secular growth. Because I am a card-carrying member of the semiconductor analyst community, I was skeptical, right? So you've now just printed 3 consecutive $1.8 billion quarters, proving the secular case. And so I will ask the same question, will this mean revert?

No. It doesn't stop here and it's really important to understand that we currently see 2 different worlds. There is a clear semiconductor cycle into compute mobile and consumer sectors. And we are exposed to it. We -- our mobile business, our IoT business was also falling like a stone. Hopefully, it got through the trough in Q1, but deep fall. Why? Because the demand in the past years was driven by the working from home in the pandemic, a very clear correlation that saturated and then you got the semiconductor cycle going. This is totally not the case for automotive. The automotive growth of the past years had nothing to do with the pandemic. If there had been no pandemic, we would have seen exactly the same growth. Secondly, the shortages in automotive, which are driving the price increases we just discussed, have nothing to do with the pandemic. It's a complete myth when people say supply chains were hit up by the pandemic. Yes, there was some compounding negative impact, but the fundamental reason for the secular growth in automotive is the content increase due to electrification and ADAS. That would have happened also without pandemic. And yes, the industry, including ourselves, we have all underestimated that demand growth for trailing edge and mature nodes as a result of that and have underinvested in the years 2017 to 2020, which is why we have then a structural supply shortage through the past years, which we've now invested in and things are coming back into balance. So therefore, my answer is automotive will continue to grow. I did say that pricing is stable. There is no concern on pricing. Fundamental demand because of content increases will continue. We do not see a cycle in automotive.

Got you. And talking about the cycle, can I ask you about the state of the supply chain, our field work suggest lead times are coming down broadly for microcontrollers? And is that the case for NXP?

Well, we still have -- I think in earnings, we said 1/3 of our portfolio is at 52 weeks or more lead time, so still above a year for 1/3 of the total portfolio, which is quite massive. So we are still plagued by shortages. However, I have to also transparently say, part of that 52 weeks is a, call it a self-inflicted cycle because we have this NCNR concept. So we have customers who absolutely want to give us full year orders because they think that gives them an advantage in supply priority, which is also the case but that means we are totally ordered out. So if now a customer wants an automotive product, obviously, it will have at least a year lead time because the year is already ordered out. So therefore, the lead times, that metric is only somewhat meaningful given that new way of running the business. I'd say that the other way to look at it is what's the amount of shortages, which we still face. And I'd say we still have some, much better than it used to be because the supply capability of NXP itself but also of our foundry partners has nicely improved over the quarters. And I dare to predict that by year-end, so Q4 of this year, we should be in a reasonable balance. Reasonable means in my -- and you said 28 years of semiconductors, something is always short. I've never seen any quarter in this industry where everything was fine. There is always something short but I'd say back to normal is hopefully the case in Q4. It's just important everybody understands this is not because the demand dropped, it is because the supply came up.

Got you. And you noted on your earnings call, your channel, I believe it's still near its lows at 1.6 months of inventory and that's a deliberate move by you. But for analysts, it's interesting to note that you look at some of the largest distributors in the world, their days of inventory are at 20-year highs. And so can you help us reconcile how you guys are low, you're keeping your channel low, but when you look at the balance sheets of some of the distributors, the biggest distributors, they're actually quite high.

You are spot on. We are completely unique in what we do. I get that feedback from the CEOs of our distribution partners all the time that we are the only one not pushing inventory into them, but actually deliberately keeping it low. So we are at 6.5 weeks of inventory across our total distribution business, which is big for NXP. It's half of NXP, is distribution. So that's a very material inventory control mechanism. We do this because we did it the other way around, like apparently, everybody else is doing it today, 6 years ago and it was bad. We had to suffer from this because inventory over time had to be adjusted. We had obsolescence issues. We had pricing issues. All of that we said this time, we don't repeat. Now to be very specific, this 1.6 months of inventory, which we have sitting there is almost a full month below our long-term target, which is 2.4, 2.5 months, which equals $500 million. So we have $500 million of revenue, where Bill and I, we have the orders. We could have decided to ship it this quarter. We could have guided $500 million higher. We deliberately don't do it given the reasons I mentioned before. We wait for the sell-through to consistently pick up. Once that happens, we will gradually ship in because then we have to make sure to not lose market share. But for now, we better keep it on our balance sheet and largely, it's in the stock, a little bit in finished goods but there is a significant difference to our peers. So it's important we all understand there is a $500 million in our pocket, if you will, to be shipped when the time is right. And additionally, as Bill mentioned, this $500 million is margin accretive because distribution revenue in NXP is more margin-rich than our direct account revenue. So that's another question, if you will, which we have going forward once we start shipping that in. So I think that puts us in a very advantageous position versus literally all of our peers. We look at all of them, I'm always hearing higher distribution inventory than our 6.5 weeks but as you say, it's a deliberate choice. I think it's a big learning from what we got wrong in the past and we will gradually and thoughtfully release it going forward. None of the guidances, which you got from us, which is the Q2 guidance or the fact that we said half 2 is going to be bigger than half 1, is based on releasing it. So everything we say so far is still based on 1.6 distribution inventory. So we don't want to spook any investor by refilling of inventories. That's not part of it. If we start to refill, which could be, then that's going to be a tailwind ahead of the guidance and ahead of the numbers, which we've given.

Great. I want to ask you about your manufacturing strategy. I think -- and it kind of dovetails to the answer Bill gave on the margin profile. Over the last 15 years, there was a movement in semis to go fab light. And that started during the time when the industry was flushed with capacity and various governments around the world took steps to integrate into the global economy. The set up today is, it seems like, it's the exact opposite, as you had mentioned with underinvestment in the supply chain or the manufacturing capabilities and geopolitical tensions escalating around the world. Can you just remind investors your manufacturing strategy in the context of this shifting geopolitical backdrop?

Yes. By the way, I think there is no right or wrong. It really depends on each company's portfolio. That's very decisive for what is the right choice. Ours is what we call a hybrid manufacturing strategy. We keep everything in-house, which is specialty processes, which are our IP. So where we own the recipe for the process technology. That's what we keep in-house and that is all 90 nanometers or bigger. So relatively old nodes, if you will. Today, that represents 40% of our wafers. So 40% in-house, 60% external, and those 60% is all by CMOS, which is 90 nanometers and smaller. Going forward, given the growth of these 2 elements, it will move to 30-70, eventually 25-75, so that the foundry part is going to grow faster. I think this is from a gross margin performance perspective, definitely the best choice for us. Bill talked about the much lower fixed cost, which we have today, that's a reflection of this manufacturing strategy. Now the geographic resilience requirements from our customers, like U.S. customers want U.S. production, European customers start to want and mandate European production, can only be fulfilled in my view with the foundry strategy because we would be never in a position to afford building factories wherever customers want to have manufacturing. I mean that's impossible on our scale. So doing this works through foundry partners. And I mean, it's all publicly known. TSMC is building in the U.S. in Arizona, the 5-nanometer process I mentioned earlier, which is taping out this month. It will be manufactured in the Arizona factory of TSMC for a U.S. customer. So we can deliver on that. TSMC is building in Japan. We are also working with GlobalFoundries, which have factories in Singapore, Dresden, Germany and Upstate New York. So we think we have an ideal geographically resilient footprint in this geopolitical turmoil. We talked about prices earlier. There is one downside from all of this, but it's totally beyond our control. It's the whole industry. In the end, you talk about fragmentation -- fragmented manufacturing strategies in an industry, which needs economies of scale, that will drive cost. So all of these factories in the U.S. and Europe are great geopolitically, but they will drive cost and we have to pass on cost to our customers. So that will lead to a situation where prices will continue to go up. So in a way that drives inflation, which is not good from that perspective, but that's the outcome. But in a nutshell, we have totally changed our manufacturing strategy. It will have much less fixed cost. It will be leaning more on foundries, which gives us very good access to economies of scale, cost and volume, geographically diversified.

Great. That is a -- I think, is a great message for investors and a great message to your customers also. So with that, that will have to be the last word. We just ran out of time. Kurt and Bill, thank you so much for joining. It's really been a pleasure speaking with you today. Thank you.

Thank you, Mark. Thanks for having us. Thank you.