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

Good morning, everyone. Welcome to day 2 of the Raymond James Institutional Investors Conference. I am Melissa Fairbanks. I cover analog semis and some of the IT supply chain names here at the company. We are really excited to welcome back -- it's been a while, but we're excited to welcome back Jeff Palmer from NXP, Vice President of Investor Relations. And I'm sure many of you have spoken to him in the past. So Jeff, thank you very much.

Thanks, Melissa. Nice to be here.

This is a generalist conference as we were talking about. And so it's always helpful just to give a little bit -- just a couple of minutes introduction.

Sure. Sure. I'm going to kind of give a little history lesson, so some of you may know this already, but I, at least I ground everyone. So a little bit about myself. I've been with NXP now going on almost 16 years. So I came to the company just at the time of the IPO. From a company history perspective, as you all know, we were carved out of Philips in 2006 by a group of private equity investors. We were private up until 2010. 2010, we went public on Nasdaq. Our background as a company was primarily in the mixed-signal security space, if you will. And then in 2016, we merged with Freescale, which was a kind of a peer company of ours, much more focused on processing and in the automotive space. So very complementary to our portfolio. So post 2016 or so, I'd say the portfolio really took a step up, and we had a much broader portfolio of analog, security, mixed signal, RF and processing. So that's our kind of our product set. We basically, as you probably may remember, we were in a failed acquisition, like Qualcomm was going to try to acquire us. That lasted for about 22 months, which was really quite disruptive to the organization. But post the Qualcomm merger, we became public again. Our current CEO, Kurt Sievers, had been running the Automotive division for many, many years prior to that. In 2018, he became the President and then the CEO. About a year later, Bill Betz, who had been running all of finance internally became the CFO. And they've really been the captains of the ship, if you will, to drive NXP to where it is today. Our focus is on industrial and automotive markets. So 75% of our revenue come from those 2 spaces. Our goal or kind of our reason for being is to deliver complete systems to our customers. The days of going and selling a socket and just being happy with yourself selling a socket are behind us. Our customers are looking much more for complete solutions where you lead with your processor portfolio, you add analog attach, you add connectivity, you add security, but it doesn't stop there. Customers expect us to provide them with software enablement. And so over the ensuing years, we added more and more software to our solutions because our customers want us to bring to them complete solutions that they can pick up and go to market fairly quickly.

Sure. Okay. That's a great intro. And actually, I'd like to start with some of the longer-term overview. You recently hosted an analyst meeting or an investor meeting late last year, kind of laid out some pretty impressive growth targets, margin targets as well. And I think the portfolio really is what is behind that and what supports those targets. So we know you're an industry leader in systems for automotive, industrial, some of the legacy area like comms and mobile solutions. But your primary focus more recently has been on accelerated growth drivers in intelligent systems to the end -- to the edge. And I think that's kind of an important distinction in understanding how NXP is maybe a little bit more differentiated than 20 years ago than pre-NXP days.

So I think the -- first off, let's kind of define what we mean by the intelligent edge. In our world, an automobile is an edge device, a very complicated edge device. But you can also focus like in our industrial business, we focus on factory automation, building automation. We have a small healthcare business, power management. So what we're finding more and more is customers are looking for intelligence. By intelligence, they want processing capability. So you first lead with your processing portfolio. And it doesn't mean we all have the same microcontroller that is pin for pin compatible, nothing like that. You differentiate your processing portfolio by different features that the products have, different interfaces, different performance levels, different power consumption. But we find our discussions with customers more and more starting with we have to write software, right? Software architects define systems. And so where does that software run? On a processor. And so we lead with our processors first, but that's only the beginning. We then have to be able to interface that digital device, the processor, to a real-world analog world. And so we sell a lot of mixed signal products that interface the real world into the processor. More and more of our customers want to have connectivity, either wireless or wired. And then security is becoming a bigger and bigger part of the industrial discussion. So many of our processors have embedded security modules in them, in the device itself. Some a little bit more powerful. Security devices are actually external to the processor. And so more and more, we're going into these industrial accounts and selling this complete system along with enablement software, right? And so that's more about what we mean by the intelligent edge. At our Analyst Day in November, we laid our growth drivers. For automotive, we said that we thought we could grow 8% to 12% over the next 3 years. Automotive makes up about 57% of our revenue. In the industrial and IoT space, we also said we thought we could grow 8% to 12%. That makes up about 18% of our revenue. So between those 2 is 3/4 of our revenue. That's the focus. That's where we put the majority of our R&D dollars.

Okay. So I think if anyone is new to the story, I highly recommend checking out their Investor Day presentation. My favorite slide is Slide 17, where you...

I remember Slide 17.

You probably -- I'm sure you made it, but -- so it's the one where we have these top line CAGRs for each individual reportable business unit. But then you drill down into that and give us very specific details. So even within some of these areas that are growing overall 6% to 10%, 8% to 12% for automotive and industrial, there are a couple of end markets that are targeted to grow 20% to 30% CAGR. Can we maybe talk about some of those specifics?

Sure. So back in -- I think it was 2021, we decided it would be helpful for investors to understand -- like we have a very, very broad portfolio. And it's very easy to get lost in all the things we do. And I've had investors say to me, this is great, Jeff, but what's most important? So back in '21, we went to a model that says, look, we have a core business, core franchises where we have very high market share. But because our market share is so high, the reality is we're probably going to grow more like those end markets, okay? But we also have, as you called out very well, very specific, what we term accelerated growth drivers. And so we basically started to parse the business into kind of core and accelerated growth drivers. So in automotive, the accelerated growth drivers, there are several. The first is what we would call software-defined vehicles. This is about a $1 billion business today for us. It's grown quite robustly. And it's -- again, it's -- you're going to think I'm sounding like a broken record. It's a processor family, but with connectivity and analog devices. These are very advanced. These are not your father's microcontrollers. These are 16-nanometer and 5-nanometer NPUs, very, very advanced processors for the automotive marketplace. That business will grow probably about 25% CAGR going forward. And if you follow the automotive business, this is a business that has a fairly long gestation cycle, meaning that once we have a product we can take to a customer and we start winning design awards, it takes 2 to 3 years before we even see revenue. And then it's a 5- to 7-year life cycle. So when we stand up at an Analyst Day, we have a fairly decent view, all else being equal, of what's going to drive the revenue. So that's one of the accelerated growth drivers, software-defined vehicles. The second one is what we term 77 gigahertz radar. This is for automated driving or safety systems for cars. This is just about a little under $900 million business. We think that will grow kind of a 15% to 20% CAGR over the next several years. We're the market leader in automotive radar systems. And just to kind of cut off the question before it happens, automotive safety is not radar or cameras. It is both. It's both modalities. And most auto OEMs want to be able to deploy both modalities in a car. So that's a decent-sized business. We then have a smaller electrification business. It's the only part of our automotive business that's dedicated just to electric vehicles. Most of our products go both into electric vehicles and internal combustion engines. For electrification, what we do is battery management systems. So if you think about an electric vehicle, there's 2 parts to that powertrain. There's the part that moves stored battery power to the electric motor, that's done via power discretes. We're not in that part of the business, but we control that system, battery management systems. It's about a $500 million business. It will grow probably in the upper teens type of growth rate in the coming years. And then we introduced another growth driver, which we call connectivity, automotive connectivity. If you think about a car of the future -- it's going to be a hierarchical processing fabric, much more like a networking system. So you're going to have much higher data rates moving data around in the car. And so we've been rolling out Ethernet switches and PHYs and other types of data networking products in the automobile. It's a smaller business today, but we think it will grow quite nicely over the next several years. So you put that all together, those groups of accelerated growth drivers for automotive will grow at about 20% CAGR over the next 3 years. And it doesn't cliff in 3 years. It's just -- we talk in 3-year windows for Wall Street. I mean our business tends to run in 5- and 10-year increments. That's how we make investments. So that's kind of the automotive business. As you can tell, that's the most important part of our company, 57% of the revenue, very profitable, very high market share. We are -- our business is very distributed globally. I mean, if you look at how production is distributed around the world, our business tends to reflect that. In the industrial market and what we call industrial and IoT, it's really kind of 2 halves of one coin. About 60% of that business is what we'll call core industrial. This is factory automation, building automation, power management and a small healthcare business. And then we have a consumer IoT business, which ranges all the way from wearables all the way up to home automation. And there -- and you and I talked about this outside for a minute, Melissa, but in industrial, there is not one killer product. It is a collection of products, and it's tens of thousands of customers that we support through our global distribution network. So distribution for us is critically important. About half of our revenue, a little bit more than half of our revenue goes through global distribution. These industrial customers, they tend to be smaller. They tend to be very smart about their end market, but they're not what I would call experts in semiconductors. So they want partners that can bring to them complete solutions that they can pick up and get to market quick. They also want solutions that are scalable, meaning they may go to market with an initial product and go, you know, we could sell more if we could maybe scale it down a little in performance and features or we can sell more if we could scale it up. Our processor family is very scalable, meaning without relaying out the system, you can move up and down that performance curve, okay? So there is not as much detailed specific drivers in the industrial and IoT business. It is really around our processors, our connectivity, our analog attach.

Okay. Bringing intelligence to the edge.

Bringing intelligence to the edge. Now you mentioned in your e-mail to me earlier about a recent acquisition we did. We acquired a company called Kinara. So one of the things we're seeing in the industrial marketplace is this need or this desire to run what we -- large language models at the edge. Now in the current environment for data center, for AI, all of that is done in a data center. We are not a data center AI play at all. We want to just put that to bed, right now, that's not who we are. But what we're finding is our customers want to run these large language models down at the edge in their factory environments, and they don't want to have to go to the cloud. They don't want to go over the network to get...

Part of that secure.

Is part of the security, but it's also latency. So what they're doing is they're taking some of these models that might have been developed in the cloud, right, for training, but then they want to compress them, make them a little tighter, a little smaller and run them for very specific applications like object classification, interfaces for like identifying people. The days of a factory worker keying in their user name are behind them, they go up and that reads the iris of their eyes, right? And so Kinara is a product. It is an NPU, a neural network processor, that accelerates the running of large language models at the edge. And it basically slaves, if you think about it, you can take an NXP processor and put multiples of these NPUs together and get 5x to 10x horsepower improvement. And we've shown to a couple of our customers that this isn't a forklift upgrade. We can go in and actually build daughter cards or plug-in cards into systems with these Kinara processors in your existing network.

Yes. That's -- we're going to get more into M&A later, but I do want to address -- I know it's just M&A strategy. But -- so at the high end, your new '27 gross margin -- 2027 gross margin target is about 600 basis points above the prior 2024 target. Now we did see some outperformance above that, the market, the environment was not exactly normal over the past several years. But discuss how this focus on the highly integrated advanced systems has impacted the margin and returns profile and where your investment has been directed over the past 10 years and how that's driving that?

Sure. So it's important to understand the journey NXP has been on from when we were carved out of Philips. When I started with the company 16 years ago, we were still quite an IDM, meaning we did most of our fabricating of wafers internally. We did buy in those days in 2011, 2012, we did about 25% of our wafers externally, the rest we've built internally. Today, fast forward 15 years later, we build about 60% of our wafers externally and only about 40% internally. Simultaneously, we shut down unproductive or trailing edge factories that didn't make sense, and our cost structure changed dramatically. So today, our cost structure is about 70% variable in nature and 30% fixed. In those days, 15 years ago, it was flipped. We were a 70% fixed cost company. So revenue is our friend. As revenue continues to grow, we're able to drive that revenue over a lower fixed cost base and drive better profitability. And we've become much more efficient in our systems, going over the next number of years, and you highlighted the gross margin targets, from '24 to '27, our target is 57% to 63%. Partially of that is really a result of improving revenue growth, which will drive higher utilization in our factory. We'll refill our distribution channel. We'll introduce new products, which always tend to be accretive to margins upon launch. That will help us drive that margins in that 57% to 63% range. But for those investors who stay with us even longer, in the post '27 period, we are in the process of building a joint venture factory in Singapore with Vanguard, which will drive another -- we think between the Vanguard factory and some other things we're doing, can drive another incremental 400 basis points of gross margin expansion on top of where we land in '27.

I'm glad you brought that up.

Okay. So there is a journey here in gross margin. It's not like we're going to hit a wall and that's the best we can do. We actually see probably at least a 5- to 6-year window of incrementally improving gross margins.

Not many -- and I imagine the focus on and having a greater percentage of industrial and automotive that tend to be longer life cycle programs for you. It gives you the visibility and the confidence in order to make these investments longer term and kind of plan for that capacity.

That's true. That's true. So the 60% that we build externally today with partners like TSMC and GlobalFoundries and a few others, these are primarily digital bulk CMOS processes. We don't build anything 90 nanometers or below internally. So externally with TSMC, our most advanced process today is 5 nanometers. We're in volume production with 16-nanometer products, 28 and so on. The remainder of the business, what we build internally is primarily mixed signal products that we build on our own proprietary processes. Now those factories that we build them on internally today, we have 3 of them, 2 in the United States and 1 in Europe. They are getting long in the tooth. They're probably about 40, 45 years old. And so at a certain point, you do need -- you can only keep an older factory running so long before it becomes inefficient. So the factory we're building in Singapore with Vanguard is a 300-millimeter factory. We will get much better cost structure from that 300-millimeter factory. Because we will actually be an equity owner, we get near-cost wafers. So it's not like we're not buying foundry wafers. We're a partner. Now this foundry that we're building in Singapore, we'll own 40% of it, but it won't consolidate into our financials.

Okay. Okay. I would like to -- not only is your manufacturing approach a little bit different than peers, I'd like to talk about your method for managing inventory and what we did during the supply chain crisis and how NXP has kind of, in my view, emerged a little bit more -- in a more healthy position than maybe some of your peers, but you did take a very different approach to managing that inventory.

Yes. So I think it should be stated that, look, we are not perfect. And in that 2015, 2016 period, we made mistakes in our distribution channel. We would -- in those days, we used to ship product to the distributors. At the end of the quarter, we do kind of a reconciliation and just kind of report it. It was good enough. And we know a number of our peers do the same thing today. We made a decision at that time that we were going to build a very highly automated system with our distribution partners. And it's very important to understand distributors like Arrow, Avnet, World Peace, they're our partners, but they actually work for us. So they sign up to our requirements. Some of the requirements we put on them in 2016 was, one, we know what we ship into Mr. distributor, by part number, by location, so on, by end market, what have you. We also mandate that the distributors tell us how much inventory they have, specific by geography, by product type, and we mandate that they give us sales out of the channel, POS, point-of-sale data so that we know exactly what data is moving, what material is moving through distribution to our customers. This has given us a very strong hand on understanding how the distribution channel is working. And this worked really well. We didn't get a lot of questions about it from about 2016 until probably 2022.

2022.

And everything was fine. We were running our channel at about 11 weeks. It was pretty stable, not a lot to see there, just we were doing a good job. We started to see some uncomfortable trends in late '22, and that was really through our distribution channel into China. We started to see some of our customers there start to get a little weak. Now we made the decision at that time, we could have either just put more product in the channel, like a lot of our peers and seen what happens. But we decided, let's use our balance sheet, keep that inventory on our balance sheet, keep the channel very lean because if you think about it, if you keep your channel lean, you're getting very real-time feedback on when things are going inflecting up or inflecting down. Sometimes when your channel is completely full, you don't get that feedback. So we made that decision in late '22, and we've been managing the channel very, very tightly since then. Our target is to run about 11 weeks of inventory in the channel. We've been running at about 8 weeks since that time. And we will refill the channel. For us, because the channel services are very long tail, it is a margin-accretive channel go-to-market for us. So when we refill the channel with those extra 3 weeks of inventory, that will be margin accretive to the company.

Okay. All right. I want to stop now and just ask if there are any questions in the audience, just in case before we move on. All right. So that is actually going to lead us to some discussion about the near-term trends, where you have seen a little bit different curve through the downturn and stabilization. And maybe talk about -- we have seen some signs of stabilization heading into the back half of last year, and it seemed to be a little bit of a head fake for the industry. So we've started to see some further correction. So if you can talk about maybe what you saw in the December quarter, what your March quarter outlook, I know this is very near term, and there is still a lot of uncertainty. But based on what you're seeing either by geography or end market.

Sure. So I'm going to take us a little bit of a step back because it's important to understand how you get where you are today. So we just spent a few minutes talking about distribution, a little bit over half of our revenue. The rest of our revenues, we sell direct. And primarily our direct customers are the large global Tier 1s in the automotive industry and a few industrial customers we take direct. But what we started to see in the spring of 2023, we had noncancelable, nonreturnable order programs with our large direct customers. Several of them came to us and said, "Mr. NXP, we know that we have a contract with you. But if you make us take that material, we're just going to put it on the shelf." And we made the decision at that time, very similar to how we manage the channel. We said that doesn't do anybody any good. Let's use our balance sheet. We'll let you "out of these contracts." We've got some compensation for it, if you will, design wins and other things and a better relationship and insights to their business. But basically, in the spring of '23, we started to see that the large Tier 1s had over-inventoried themselves. And we've been working with them since that time to help them get out from underneath some of that inventory, right? And so what it's done to us is we've seen lower sales. So our peak was lower, but also our trough was higher. And so since '23, all through '24 and here into the early part of '25, we're still working with these Tier 1s to help them rationalize some of their inventory. What we see very tactically today, and we said this on our earnings call, it's a very cloudy environment. There's not a lot of clarity on the next move. For those of you who follow the auto industry, you know it is a very deep supply chain and it's very sentiment driven. When the auto OEMs are feeling neutral to negative, that sentiment amplifies through the supply chain to us. And what it means to NXP, bad business conditions. When the auto OEMs are starting to feel neutral to slightly positive, that amplifies and what does that do to us? Hurry up to ship us more product, right? And so I think where we're at right now is we're probably getting close to that inventory digestion being complete. We don't want to call when that happens. We've been guilty of head faking before. We read the tea leaves last year, and we thought the second half of '24 was going to be stronger, and we were wrong. And so we've made the decision we're not going to go over our skis here in '25. We gave you a view of what we thought guidance would be for Q1. We gave a slight indication of we thought Q2 might be flat to slightly up, but that's as far as we're going to go because the environment is so cloudy, and we just don't feel -- we've kind of put away our crystal ball, if you will.

This is a quick question kind of off script, but I am curious about your automotive business, where your exposure is. We know that some of the EV platforms, they don't work on a traditional model year, like what we've seen with the traditional OEMs. How much of your business is kind of tied to this non-model year, maybe we get intra-year upgrades or new platform launches versus the traditional OEMs that we generally see this back half build?

So I'm not sure this is what the question side of the question, but it's very clear to us, having spent most of our lives in the auto industry, the China electric vehicle companies are winning that battle versus the Western OEMs. It just appears to be that way. Good or bad, I'm not going to weigh in on that, but we -- our exposure from an auto OEM perspective is very global. So if you were to look at global production by geography, it is relatively similar to our business. So we have a large percentage of our business in China. As a matter of fact, China in total is about 36% of our revenue on a ship-to basis. About half of that is for multinationals for reexport, and about half of it is for China-headquartered companies, some for reexport, but some for local consumption. I would say the way we operate with the auto OEMs is not so much on a model year-by-model year basis because you will have a model year and the guts, if you will, the electronics don't change every year.

The platforms stay the same.

The platforms stay the same.

So amazingly, we only have a few minutes left. I do want to get to the capital return strategy because I think that this is an area where NXP has really excelled, and we've seen a little bit at times, some multiple expansion, which is always what we like to see. But maybe talk about -- you did mention the Kinara acquisition. You have done a number of kind of smaller tuck-in, maybe it's technology or capability acquisitions. But talk about your shareholder return policy beyond internal investment.

Sure. So it's a very, very simple capital return policy, and I'm going to make it very simple. Our goal is to return all excess free cash flow to our owners. And our track record proves that out. Since 2018, we've returned, I think, $17 billion of cash to our owners through a combination of share buybacks and dividends. There's nothing going to change there. So long as we are below 2x net debt to trailing 12-month adjusted EBITDA, we will be in the market buying our shares. That's our kind of go/no-go on buying our shares. We view a dividend almost like debt. So it's sacrosanct. Once we put a dividend in place, we're not going to touch it. And we don't see any reason why that would change going forward. For those of you who invest in semiconductor companies, a well-run chip company generates a lot of free cash flow because we have a hybrid manufacturing model. We don't have a high CapEx model. Our CapEx is sub 5% because we're a hybrid company. So you as investors and owners of our company can count on is every year, we will return all excess free cash flow to you through dividends and buybacks. Now it won't be linear the same amount every quarter, but I've looked at this over long periods of time, and it shows that I think since 2018, it's been 109% of free cash flow generated we return to our owners. So it's very simple.

Definitely sets NXP apart for sure. So we only have 1 minute left. Do you have closing remarks?

I do.

Maybe I think that, that was a really good point to...

Well, I'm going to leave you with kind of this very simple idea, and I've talked to Kurt, our CEO, about this. I'm a firm believer that people can remember 3 things and only 3 things most days. So the 3 things to remember about NXP, if you want to be an owner is, one, we think we can grow organically in the high-single-digit range over the foreseeable future. We've given you laid out exactly how that's going to manifest itself between now and '27, but that growth rate should continue even beyond. Two, we talked about our gross margin expansion story. It's a fairly robust gross margin expansion story. And third, we're going to return all excess free cash flow to our owners. So those are the 3 things for NXP. If we do that correctly, we believe we can double our EPS by 2030. So we just finished '24 at about $13 a share. I'll let you do the math and chainsaw it out, you can kind of see where that should be in the next several years.

Excellent. All right. We are at time right now. Thank you so much for joining us, Jeff. I really appreciate it.

My pleasure. Thank you, everyone.