The Newsletter, Transcripts
NXP Semiconductors N.V. (NXPI) Presents at 51st Annual JPMorgan Global Technology, Media and Communications Conference (Transcript)
Start Time: 08:40 January 1, 0000 9:09 AM ET
NXP Semiconductors N.V. (NASDAQ:NXPI)
51st Annual J.P. Morgan Global Technology, Media and Communications Conference
May 22, 2023, 08:40 AM ET
Company Participants
Bill Betz – CFO
Jeff Palmer – VP, IR
Conference Call Participants
Harlan Sur – JPMorgan
Harlan Sur
Okay. Let’s go ahead and get started. Good morning and welcome to JPMorgan’s 51st Annual Technology, Media and Communications Conference. My name is Harlan Sur, semiconductor and semiconductor cap equipment analyst for the firm.
Very pleased to have Bill Betz, Chief Financial Officer; and Jeff Palmer, Vice President of Investor Relations at NXP Semiconductors here with us today. NXP is the top three global microcontroller supplier and the world’s second largest automotive semiconductor supplier. Bill and Jeff, thank you for joining us today.
Bill Betz
Thanks, Harlan.
Harlan Sur
Semiconductor industry revenues forecasted to be down about 10% to 12% this year. Obviously, we’re in the midst of a cyclical down cycle for the group. Consensus has your revenues down 2% to 3%, so significant outperformance by the NXP team.
Relative to your 2021 Analyst Day financial targets, even with the downturn, you’re driving a two to three-year revenue CAGR that is still within your financial target of 8% to 12% revenue growth on an annualized basis and margin profile that is above your target range, the outperformance clearly driven by exposure to auto, core industrial which has held up well, disciplined inventory management by the team and the six accelerated growth drivers which we’ll talk about, and that you also laid out at your Analyst Day about 18 months ago.
So I guess starting off from an end market perspective, can you guys just take us through what the team is seeing in the first half of this year and anticipated profile of the business through the second half of the year?
Jeff Palmer
Yes, I’ll take that one, Harlan. So what we saw in the first half of the year, we did see some better supply that allowed us to grow our auto and kind of core industrial businesses better. We probably were overly conservative in our outlook into the first quarter given a kind of unknown of what was happening with the China reopening. So we did do better than we originally had anticipated versus our Q1 original guidance.
We did make this statement on our earnings call a couple of weeks ago that we thought the second half would be larger than the first half and in absolute terms, and how to kind of build that up as it assumes that auto and core industrial continue on the same trajectory they’re on, so no deceleration there. We do have a premium handset customer that has pretty normal product launches in the second half of every calendar year. And they appear to be on track for this year. So that will provide some tailwind.
And then on top of that, we’ve been able to provide some supply to our secure cards business, which has had some pent-up demand for the last couple of years. And then also the RFID tagging market is finally becoming material after a number of years of waiting for. So you put all those together and mathematically, you do see the second half being larger than the first half.
What it doesn’t contemplate is we don’t anticipate a significant rebound in China. If that was to occur, great, but it doesn’t contemplate that. And secondarily, it does not contemplate us refilling our distribution channel above the 1.6 months level that we’ve been running it out for quite some time. So pretty natural growth, if you would.
Harlan Sur
Perfect. And then on the supply side, the team mentioned back at earnings, one-third of your products still carry 52-week lead times. This mix should continue to drop as you move through the second half of the year. But if we look back, however, your historical average lead times I think is around 15, 16 weeks. And my guess is that although a majority of products have fallen below 52-week lead times, they’re still well above historical pre-COVID-19 kind of mid-teens levels. Is that the case, number one? And does that suggest that mature node wafer availability is still somewhat tight?
Bill Betz
Yes, let me take that question, Harlan. The way to think about the one-third comment that we made. As you know, we entered into non-cancelable, non-returnable orders for about one year. So think about that supply being used up related to those type of orders. And then the rest of the portfolio is what we tried to indicate is back to normal. Related to what’s still tight on the technology nodes, we still remain tight on 55, 90 and 180. And we expect those to hopefully by the year end work each other out and be back to somewhat normal as we look ahead into 2024.
Harlan Sur
Perfect. And your channel inventories, customer distribution inventories are 1.6 months and still sitting 35% below pre-COVID-19 levels. The team has been pretty smart about keeping channel inventories low which drives maximum customer responsiveness and a more real-time gauge on demand inflexion and also provides NXP with some flexibility. I know you said that the second half outlook doesn’t contemplate any channel replenishment. But given the high responsiveness that you get from your customers, especially on inflexions that they see on your business, has the team thought about keeping the channel inventory targets sustainably below that sort of 2.4, 2.5 months sort of historical range?
Jeff Palmer
I’d say no. I’d say one of the things that — the 2.4 months is kind of based on how you could provide optimal service, right? You do want to have material on the shelves for your distribution sales people to sell readily. The whole idea currently about keeping it 1.6 has been to keep the inventory on our balance sheet, because it gives us maximum flexibility. Because once you sell a product into distribution, it basically title transfers and we can’t redirect them. So in this current environment where things are tight, it’s an uncertain demand environment, it’s best to keep maximum flexibility on our balance sheet. But over time, the goal is to bleed off the balance sheet inventory into the channel. But that will take multiple quarters. That won’t happen all at once.
Bill Betz
And the size of that magnitude is roughly about $500 million when we believe the market and our customers are needing it. Like Jeff said, it’s sitting in die bank. It takes us about three to four weeks to finish it out. And we’ll be able to serve it. So we feel very good about that.
Harlan Sur
Yes. So it’s in die bank. So as you mentioned, very quickly for the team to sort of bring it to market, so you’re primed for that. So my question is you have seen a better second half outlook. I think a lot of your consumer businesses you feel like are sort of bottoming. So what are the metrics triggers, signs for the market that you’re looking for to start to take those channel inventories back up?
Jeff Palmer
It sells out of the channel. So if you look at — if you think about a channel to sell in where we recognize revenue and sell out, we monitor both of those as well as inventory in the channel on a daily basis and we review it as a management team weekly. If and when we see sales out of the channel begin to incrementally steadily improve and re-heal as we kind of go through this trough of the environment we’re in right now, we will take the action to slowly rebuild the channel.
Harlan Sur
And I guess to follow up on that, your China business is mainly through a sort of distribution, so post zero COVID policy elimination end of last year post Chinese New Year’s this year. Consumer and corporate demand in the region has been more muted, right? And although it did perform better than you anticipated, in Q1, China exposed businesses, which are more IoT and mobile, appeared to have stabilized at least. Has the team started to see signs of a pickup in distribution sell-through in the region and –?
Jeff Palmer
Clearly, it was better than we had anticipated. If you think about the conversations we had internally in the fourth quarter getting ready for the earnings call, we were uncertain about how the China market was going to evolve. So we took a very conservative view and how we projected our guidance for Q1. It was better, it is incrementally better. But we don’t think it’s a huge rebound at this point.
Harlan Sur
And is it just because that it’s not broad-based? Are you just seeing it primarily in, let’s say, your auto end market or –?
Jeff Palmer
No, it’s across the different end markets that are service by distribution, but it’s not back to where it should be and where we’d like to see it.
Harlan Sur
Yes. Okay.
Bill Betz
I think we’ve maybe gone past the trough. But are we — on the accelerated other side of that trough, Harlan, is not certain yet?
Harlan Sur
Okay, perfect. Any questions from the audience? If you have any questions, just raise your hand and we’ll get a mic to you. You have a question up here?
Question-and-Answer Session
Unidentified Analyst
Hi. Thanks. You gave us some brief comments about auto in your opening remarks. Could you maybe just put some more numbers around the inventory levels and how you see that playing out for the second half of the year?
Bill Betz
When you say inventory, you mean inventory at customers?
Unidentified Analyst
Yes.
Bill Betz
So as probably most of you know, it is near impossible for us as a semi vendor to give you an exact sense of how much inventory is at the tier ones who is our primary customers we sell to. Now through conversations we do hear anecdotal, there might be some small pockets. We spoke about this on our earnings call, two particular tier ones in Europe, but we — it really wasn’t an excess across the board. It was really as a result of kind of a golden screw problem where OEM couldn’t get a component from another vendor. They had had enough of our product and other products, but we don’t really have a sense of how much inventory is there. That is the fundamental channel of the way the supply chain works.
Unidentified Analyst
Thank you. I was wondering if you could make some commentary about what some people see as a lot of incremental capacity coming online globally, especially from Chinese domestic players on the microcontroller market.
Jeff Palmer
Yes. So for us, our primary partners for foundry has — about 60% of our revenue we sourced from the foundry marketplace, just to level set you. Our primary suppliers are TSMC, GlobalFoundries, a little bit of Samsung, primarily those vendors. Our customers have become very risk averse and they are not open to taking product built in kind of what I would call second tier foundries in mainland China. So while there is probably more capacity coming online, our customers are not qualifying that product.
Harlan Sur
I think the second part of his question was just competition from some of the up and coming China microcontroller players.
Jeff Palmer
So we do see some low end microcontrollers in China more for the industrial IoT side of the market. No one yet looking like they’re delivering auto qualified type products. It’s not a matter of never happen. It probably will at some point, can’t deny that. But we’re not seeing design win-loss or anything like that at this stage, still very low level type of competitive products.
Harlan Sur
Any other questions? We got one right here.
Unidentified Analyst
Yes. Thank you for taking my question. So on the topic of microcontrollers, when do you foresee we’re going to reach a balance between supply and demand? And at the same time, what would that imply for ASPs for 2024.
Bill Betz
So we think that by the end of this year and into calendar ’23, we should be in a more equilibrium of supply and demand, not just on microcontrollers but our total product offering.
Unidentified Analyst
Thank you. And just as a follow up on the China market, do you think we could see a bifurcation in terms of pricing very aggressive for the lower quality products and less so for the kind of products that you’re selling?
Bill Betz
It’s a case by case. We try to not sell our products on a price basis, but on a value to the customers. If the customer does not value the technology we’re bringing to the table, then it may not be the perfect opportunity for us to engage on.
Harlan Sur
The highest volumes for NXP are centered around I believe 28, 45, 55, 65-nanometer manufacturing nodes, which I assume are technologies that you outsource to your foundry partners. You mentioned 55, 90 in particular as products that are still in tight supply, but not that long ago I remember we had a discussion discussing the longer term industry capacity expansion profile on these mature and specialty nodes that would probably continue to grow slower versus the actual demand curve, keeping the supply-demand relatively tight, and I’m talking about over the next few years. Even as we move through this period of slow demand, longer term in discussions with your foundry partners, your internal capacity plans, do you still see industry capacity and maturing specialty still trending below the demand profile?
Bill Betz
I think in the short term, the answer is probably yes, Harlan. Our foundry partners are deploying capital and CapEx for new capacity. I would say it’s not just a floodgate. For ourselves internally on that 40% of our capacity that we build internally, we have reoriented our factories to be primarily mix signal proprietary processes. So we push it on all bulk CMOS out of our own factory. So our foundry network internally is all mixed signal. We aren’t building any new greenfield capacity there. We have a fix for our walls in our different facilities. And we’re just reconfiguring it right now. And that will take probably a couple more years until we’re completely done with that project. We’re probably in the process for a couple years already.
Harlan Sur
And in the U.S., we had the National Defense Authorization that was signed off by Congress back in December. It is basically a sign off on the defense spending budget for the year, but there was some additional verbiage that was put in there around U.S. government applications and restrictions around China-focused semiconductor content or China foundry-based content going into government applications and having restrictions put around them. This has catalyzed a lot of the OEMs out there; auto, industrial OEMs, Stacy the writing on the wall [ph] and they’re already starting to make moves around over the next few years trying to secure their suppliers that are more U.S. or European based, right, with manufacturing in the U.S. or European. Has the NXP team seemed that level of engagement step up because of some of these dynamics just even over the past six to nine months?
Bill Betz
Yes. And we’ve had a number of large OEMs have come to us and said, if you want to bid on this program, you have to show us the supply is sourced either in domestic in the United States or in Europe. Of our 40% that we build internally, we have one factory in the Netherlands and we have three factories here in the United States; two in Texas, one in Arizona. And then we have a joint venture in Singapore with TSMC. So I think from an already owned factory footprint, we’re very well aligned to that kind of mindset of domestic or geopolitical derisking, if you will.
Harlan Sur
Yes. Let’s drill down into some of your end market segments. So automotive, based on first half ’23 annualized revenue estimates, you guys are driving a 16% CAGR on auto over the past two years. It’s tracking well above your 9% to 14% revenue CAGR target, so strong outperformance here. You’ve obviously got a solid anchor of core portfolio of sensing, processing, control applications.
In electrification and EV, let’s start off there. Good portfolio of products. Businesses basically doubled in electrification in calendar ’22 to $400 million. You’ve essentially hit the targets that you laid out at your Analyst Day about two years ahead of plan. So one of the drivers obviously is EV production, right? That continues to be strong. But what else in electrification is driving the strong growth dynamics for the NXP team?
Jeff Palmer
I think the biggest one, Harlan, you kind of hit on it there is our view — when we originally put out that view of our electrification business going from $200 million to $400 million, we had a certain view of what the penetration of electric vehicles would be in global production. Clearly, it has gone much faster than we had anticipated. And so that has benefited us. We’ve done very well with a lot of the local Chinese kind of startup companies very well. We do have a number of European OEMs who have adopted our electrification business. And so we feel very good about that trajectory continuing as it has progressed so far.
Harlan Sur
One of the other dynamics and one of the accelerated growth drivers for the team is your S32 domain and zonal processors solution platforms. That was about a $300 million business in 2021. It’s, I believe, tracking to your 25% CAGR target through 2024. The trend in domains, zonal computing is leading to significantly higher requirements for compute, power in the car, you guys have highlighted a number of wins with the major OEMs. But you’ve also said that the ramp — you’re hitting your targets, but the strong ramp really doesn’t begin until 2025. So we understand the goal dynamics between now and 2024. How does that revenue profile unfold beyond 2025?
Bill Betz
Great question, Harlan. So it’s probably one of the most exciting areas of the business and the whole kind of driver fundamentally pushing that is this idea of the software defined vehicle. And the challenges the OEMs are re-architecting their vehicles completely ground up. That does take time. And from what we can tell from the design wins we’ve been awarded, the near curve, the growth begins in ’25 and ’26. We’ve not put a growth rate on it, but it is significantly higher than the roughly 25% that we’re going to experience between ’21, ’24.
Harlan Sur
Let’s move to your core industrial. 60% of your industrial business is core. What will you guys consider core industrial? It’s levered to strong multiyear demand trends factory automation, energy infrastructure, building automation. The team here continues to leverage your strong processor end market leadership, drive increasing attach rates to your connectivity, analog, power management, security products. So I think a good reflection of this is that your crossover and i.MX application processor families grew 50% year-on-year in 2022. So help us understand what’s driving the design win traction with the i.MX portfolio? And you guys probably do track this. What’s the rough attach rate of your analog, power, connectivity products when you do win an i.MX socket?
Bill Betz
So for the i.MX family in particular, Harlan, I would say the attach rate of PMIC was probably 100%. Because for most advanced processors, the PMIC is kind of designed in cooperation with that design. Some of the crossovers may not need a specific or custom PMIC, so it’d be less than 100. I’d say we are still learning how to sell the complete kit, not just the processor and the PMIC, but also the WiFi attach and the other type of connectivity attach. I would say we’re still in the early days there, probably clearly not even 50%, but doing well.
Harlan Sur
Any questions from the audience? Let’s talk about your comms infrastructure and other semi, because you did mention it in your prepared remarks. In addition to auto, core industrial, your comms infrastructure and other has actually been a very resilient business, right? It turns out you have some nice drivers of the business in RFID, secure card access. So what are the applications driving these two product segments? And what’s your view on the service providers spending trends in the comm infrastructure side of that segment?
Jeff Palmer
So like all companies, Harlan, we have — our comm infrastructure segment is a catch-all multiple different product portfolios and really consists of three unique non-interrelated portfolios; one, our RF power products for the base station market. That market continues to be very, very lumpy. I think the one opportunity we see in the intermediate term is kind of carrier build outs in India, but it will be lumpy. And so far, it’s not been substantial so far this year.
The second one is our cards and tagging business. So there’s two parts of that business to think of. There’s been a pent-up demand in our e-government and some of our banking card businesses and transit cards. And this is a business that during the pandemic, we just was short capacity and it was a bit starved. Now we have been able to apply some capacity there, and that’s been good.
The part that’s more secular in nature has been the RFID business. And this is something we’ve been investing in for a number of years. It’s been one of those kinds of ideas long in the tooth waiting to really take off. And the idea is to be able to do individual tagging of components and track components through a supply chain by consumer products is what I mean. That business has really started to take off quite substantially and will probably play out very well over the next several years.
And then the third portfolio inside of that comm infra is our multi-core digital networking business. It’s a kind of a sunset business that came to us from Freescale. Not overly focused on it, but it has continued hanging in there pretty well. But at some point it will sunset in the distant future.
Harlan Sur
I’m going to rewind back to auto because I forgot to touch upon one product, which is one of your other accelerated growth drivers, which is radar, right, strong leadership position in 77 gigahertz. That was a $600 million business in 2021. It is expected to drive to $1 billion in 2024. Is the team meeting its growth targets there? Obviously, you’ve got an expanding pipeline, more radar sensors per car. But yes, just wanted to know is the team on track to hit or exceed its targets for radar?
Jeff Palmer
Clearly on track. Where we’re focused right now is actually winning the new opportunities that will go into production post ’24. So if you think about it, the design wins that will drive that $600 million to over $1 billion business have already been won and we’re monetizing them. The way to think about that business, what drives that business, it’s kind of a three-way multiplicative business. Every year there are more cars with radar. In each car there are more nodes of radar. And each year there’s more demand for functionality in each of those nodes. Each of those kinds of opportunities drives revenue for us.
Harlan Sur
Got it. Any questions from the audience? Okay. On the financial front, gross margins are already above the high end of your target model, even as the team is driving mid 70% utilization levels here in the June quarter. Additionally, I believe the team’s new product pipeline is at gross margin levels that are accretive to your current gross margin. So how should we think about the trajectory of gross margins from here because it looks like the bias appears to be to sustain or expand above your target range as revenues expand from trough levels here in the first half of the year?
Bill Betz
Yes, Harlan, for the rest of the year, we expect our gross margins with what we can see to be at the high end of the model plus or minus the 50 basis points in any given quarter related to it. And yes, you’re right. We’re running utilizations in the mid 70s. Because Jeff mentioned earlier, we are retooling, reconfiguring our factories. 8% [ph] of the CapEx we’re spending on, 75% of that CapEx is going into the frontend internally, as we focus on the IP proprietary information. But what’s offsetting that, because again 85% is roughly the sweet spot where you recover enough fixed costs. What’s offsetting that is the mix, the way we service our revenue. So it’s not by segment, obviously by product.
Inside the segments, gross margins are different. But it’s really if you think about it between direct and distribution, last year we ran distribution in the mid 50s. And the way to think about distribution is low volume, high margin. In Q1, if you can tell, we serviced distribution only at 48%. And we expect distribution, how we service our customers going forward for the rest of year be higher than that and therefore distribution having the lower volume, higher margin versus the direct business, which typically has higher volume, lower margin. So that’s a nice tailwind to offset the headwind of the underutilization on the frontend.
Harlan Sur
I’m going to go back to your industrial and IoT segment here, 40% of the businesses that bridge [ph] to more consumer IoT applications like smart home, connected gateway, and so on, this business has a higher sort of tier two business with a long tail of customers and particularly strong exposure to China. I know this goes back to our prior question, but this is one of the first segments I think where you guys started to see weakness. What are you seeing there in terms of demand consumption? I know we talked about maybe seeing some better trends in POS in China. Is this one of the segments which is driving that sort of goodness that you’re seeing out of China distribution sell through?
Jeff Palmer
So, Harlan, I’d say the consumer IoT business is better than our conservative outlook in Q1. But it’s not back to where it was where we would expect it today.
Harlan Sur
Any questions from the audience? Capital return program, so the team has had a very, very strong program targeting 100% free cash flow return. Obviously continues to be under promise and over deliver on that front. How do we think about — how the team thinks about allocation between dividend and share repurchase?
Bill Betz
Yes, there’s no change to our capital allocation policy. Obviously, like I mentioned on the call, we are buyers. We like to cost average. We are buying back the stock. And the way we get comfortable around that is we take our most pessimistic view internally and we do the intrinsic value on that. And clearly, the stock price is very attractive. Dividend, as you all know, we raised it last year 50%; this year, another 20%. I think it’s running around a bit higher than the 25% of cash flow from operations. I think it’s around 30. So we feel very comfortable with that.
That’s more fixed in nature. We are holding a little bit extra cash on the balance sheet that will give us the opportunity if we do choose so, but a lot more options at play here; buy back the stock, increase the dividend, as well as maybe pay down our debt that’s due in 2024 of March. But again, the best use of the cash is to reinvest in the business. And we believe we have a consistent policy here and expect to return 100% of the excess cash flow back to the owners.
Harlan Sur
Perfect. Well, we are just about out of time. Bill and Jeff, I want to thank you today for your insights and I look forward to continue to see the team execute as we move to the second half of this year.
A – Bill Betz
Great. Thank you so much.
A – Jeff Palmer
Thank you.