NXP Semiconductors NV (NXPI) — Q4 2019 Earnings Call Transcript

Thank you, Chrystal. Good morning, everyone. Welcome to the NXP Semiconductors’ fourth quarter 2019 earnings call. With me on the call today is Rick Clemmer, NXP’s CEO; Kurt Sievers, NXP’s President; Peter Kelly, our CFO. If you’ve not obtained a copy of our earnings press release, it can be found at our Company website under the Investor Relations section at nxp.com. This call is being recorded and will be available for replay from our corporate website. Our call today will include forward-looking statements that involve risks and uncertainties that could cause NXP’s results to differ materially from management’s current expectations. These risks and uncertainties include, but are not limited to, statements regarding the macroeconomic impact on the specific end markets in which we operate, the sale of new and existing products, and our expectations for the financial results for the first quarter 2020. Please be reminded that NXP undertakes no obligation to revise or update publicly any forward-looking statements. For a full disclosure on forward-looking statements, please refer to our press release today. Additionally, during our call today, we will make reference to certain non-GAAP financial measures, which exclude the impact of purchase price accounting, restructuring, stock-based compensation, impairment, merger-related costs, and other charges that are driven primarily by discrete events that management does not consider to be directly related to NXP’s underlying core operating performance. Pursuant to Regulation G, NXP has provided reconciliations of the non-GAAP financial measures to the most directly comparable GAAP measures in our fourth quarter 2019 earnings press release, which will be furnished to the SEC on Form 8-K and is available on NXP’s website in the Investor Relations section at nxp.com. Now, I’d like to turn the call over to Rick.

Thanks, Jeff, and welcome everyone to our conference call today. NXP delivered full year revenue of $8.9 billion, a decline of 6% year-on-year, against the very challenging semiconductor industry backdrop throughout the year. Even with lower sales volumes, we successfully improved our non-GAAP gross margin by 60 basis points and our non-GAAP operating margin by 30 basis points, clearly better operating performance than in previous market downturns. Our free cash flow conversion was solid at $1.9 billion, and we continued to execute on our capital return strategy, returning nearly 95% of free cash flow generated or $1.8 billion to our owners. As a reminder, we have returned $6.8 billion to our shareholders through share buybacks and cash dividends over the last two years, and have reduced the diluted share count by 60 million shares. Kurt will provide more details on the quarterly trends in a few moments. Notwithstanding the semiconductor market environment during 2019, we continued to invest and execute our strategy within our target markets. We introduced many new products. We’ve been actively engaged with customers on adopting these solutions which we believe will support our long-term growth targets. If you attended our Investor Open House at the CES trade show, you saw a glimpse of how some of these products will be used in real-world applications. These included automotive radar solutions, providing improved driver safety; our family of quad-core i.MX processors, which enable new multi-display digital clusters; and our innovative battery management solutions for hybrid and fully electric vehicles. We also demonstrated our latest ultra-wideband solutions for secure access and localization with a mobile device for automotive smart home and smart building solutions. Additionally, we showcased multiple new processor families including the i.MX 8M Plus, the first i.MX family to integrate neural-net processing, offering higher performance per dollar than GPU solutions. The RT crossover family for the secure edge computing market, the quad-core i.MX 8 for industrial and high-end home automation applications, and the high-performance, fully ASIL D compliant, S32G for automotive network domain control. Taken together, the wave of new product introductions across the Company and associated customer engagements is truly impressive, and there is more to come over the coming periods. The NXP product portfolio is in its most competitive and innovative position in many years, and it’s just beginning to fully reflect the synergy we envisioned when NXP and Freescale merged in 2016. We are confident that as new products ramp into volume production, they will underpin both our top line growth and our longer-term gross margin targets, and will yield significant cash flow. Then, as the end markets begin to rebound, which we are beginning to see, especially in our automotive and industrial end markets, we anticipate a healthy improvement in our core business, which will also provide positive tailwinds to growth. In summary, as we begin a new year, the team is invigorated and fully engaged. Our strategy continues to yield positive results and the customer response to new product is very encouraging. I’d like now to pass the call over to Kurt to discuss the results of the full year and the current quarter and provide an outlook for Q1.

Thanks very much, Rick, and good morning, everyone. We appreciate you joining the call today. Today, I want to review both our quarter four as well as our full year 2019 results. Overall, our Q4 results were above the midpoint of our guidance with contributions from the mobile, automotive, and industrial IoT markets, all stronger than planned, while demand in the communications infrastructure market performed as anticipated. Taken together, NXP delivered revenue of $2.3 billion, about $30 million above the midpoint of our guidance range. We closed the acquisition of the Marvell connectivity assets in early December, which was not included in our guidance. The connectivity assets contributed about $6 million of revenue to our quarter four results. Non-GAAP operating margin was a strong 29.9%, about 30 basis points below guidance as a result of closing the Marvell transaction in early December. Now, let me turn to the specific trends in our focused end markets. Starting with automotive: full-year revenue was $4.2 billion, down 7% year-over-year as a result of lower industry-wide order production and rationalization of the global auto supply chain. Our growth automotive products group year-on-year primarily due to the ramp of radar and battery management system solutions. During quarter four, our automotive revenue was $1.09 billion, down 1% versus the year-ago period at a lesser rate of decline than in the previous quarters, and showing 5% sequential growth and better than our guidance by $9 million. Included in our quarter four results in automotive was about $1 million associated with the newly acquired Marvell wireless assets. Turning to our industrial & IoT segment: full year revenue was $1.59 billion, down 12% year-on-year as global trade concerns impacted demand for broad-based general-purpose MCU products. The demand trends for our industrial i.MX application processors were flat on a year-over-year basis. During quarter four, industrial IoT revenue was $415 million, down 5% versus the year-ago period, down 3% sequentially, and $5 million better than our guidance. Included in our quarter four results for industrial & IoT were about $5 million associated with the newly acquired Marvell wireless assets. Turning to mobile: full-year revenue was $1.19 billion, up 2% year-on-year. During the year, we experienced continued strong adoption of our secure mobile wallet and transit solutions, which was partially offset by anticipated declines in our semi-custom mobile analog interface business. We estimate the attach rate of mobile wallets increased to about 35%, in line with our expectations and very supportive of our 50% attach rate targets, exiting 2021. During quarter four, mobile revenue was $332 million, down 3% versus the year-ago period, up 3% sequentially and $15 million better than our guidance. Lastly, turning to our communications infrastructure and other business: full-year revenue was $1.87 billion, up 5% year-over-year. During the year, we experienced robust growth associated with NXP’s RF power products due to the adoption of the Company’s massive MIMO solutions for the cellular base station markets as mobile carriers began to increase network densification efforts ahead of future 5G cellular deployments. The strength in the cellular base station market was complemented by stabilization in the Company’s communication processor business. However, these positive trends were offset by year-on-year declines in the Company’s secure bank cards and e-government businesses. During quarter four, revenue was $457 million, down 5% year-over-year, down 3% sequentially, and in line with our guidance. Now, let me turn to our expectations for quarter one. Our guidance reflects what we view as an improved demand environment that is moderately better than we’ve seen over the last number of quarters. It appears that the channel rationalization trends we witnessed throughout 2019 have essentially played out, both with our direct customers and those served through global distribution. We are guiding quarter one revenue at $2.23 billion, up about 6% versus the first quarter of 2019, within the range of up 5% to 8% year-on-year. From a sequential perspective, this represents a decline of about 3% at the midpoint versus the prior quarter. At the midpoint, we anticipate the following year-over-year trends in our business for quarter one: automotive is expected to be up mid-single digits versus Q1 2019 and down low single digits versus Q4; industrial IoT is expected to be up in the 20% range versus quarter one 2019 and up high single digits versus quarter four 2019; mobile is expected to be up in the low double-digit percent range versus the period a year ago and down in the high teens versus Q4 2019; and communication infrastructure and other is expected to be down in the high single-digit range on a percentage basis, both year-over-year as well as sequentially. Lastly, our aggregate quarter one guidance does include about $60 million contribution from the acquired Marvell assets, and at the same time, it excludes the mobile VAS business of which we disclosed the divestiture yesterday. For your reference, the mobile VAS business contributed $150 million in 2019. In summary, our new product introductions, customer engagement levels, and design win momentum in our strategic focus areas continue to be very positive. We remain optimistic about the mid to long-term potential of NXP, and now, I’d like to pass the call to Peter for review of our financial performance.

Good morning to everyone on today’s call. As Kurt already covered the drivers of the revenue during the quarter and provided a revenue outlook for Q1, I’ll move to the financial highlights. In summary, our fourth quarter revenue performance was above the high end of our guidance range with improved non-GAAP gross profit and in-line non-GAAP operating profit. I’ll first provide full-year highlights and then move to the fourth quarter results. Full-year revenue for 2019 was $8.88 billion, down 6% year-on-year, of which 140 basis points was the elimination of the MSA in 2019 versus 2018. We generated $4.75 billion in non-GAAP gross profit and reported a non-GAAP gross margin of 53.5%, up 60 basis points year-on-year. Total non-GAAP operating expenses were $2.18 billion, down $99 million year-on-year. Total non-GAAP operating profit was $2.57 billion, and non-GAAP operating margin was 29%, up 30 basis points year-on-year, despite a $530 million drop in revenue versus 2018. Non-GAAP interest expense was $265 million, cash taxes for ongoing operations were $120 million, and incidental taxes were $248 million with non-controlling interest of $29 million. Stock-based compensation, which is not included in our non-GAAP earnings, was $346 million. Full-year cash flow highlights include $2.37 billion in cash flow from operations and $503 million in net CapEx investments, resulting in $1.87 billion of non-GAAP free cash flow. During 2019, we repurchased $1.44 billion of our shares and paid cash dividends of $319 million. In total, we returned $1.76 billion to our owners, which was 94% of the total non-GAAP free cash flow generated during the year. We also spent a similar amount on the acquisition of the Marvell assets. Now, moving to details of the fourth quarter. Total revenue was $2.3 billion, down 4% year-on-year at the high end of our guidance range, of which 110 basis points of the decline was the elimination of the MSA. The quarter included $6 million of revenue associated with the acquisition of the Marvell assets, which closed in early December and which was not included in our guidance. We generated $1.25 billion in non-GAAP gross profits and reported a non-GAAP gross margin of 54.2%, up 110 basis points year-on-year and in line with the midpoint of our guidance, despite the small headwind created by the Marvell acquisition. Total non-GAAP operating expenses were $563 million, up $20 million year-on-year and $32 million from the third quarter. This was $18 million above the midpoint of our guidance and about $8 million of this was due to the operating cost associated with the Marvell asset acquisition and the majority of the remainder to greater than anticipated new product introduction expenses. From a total operating profit perspective, non-GAAP operating profit was $687 million and non-GAAP operating margin was 29.9%, down 50 basis points year-on-year, driven by lower revenue. Non-GAAP interest expense was $77 million, cash taxes for ongoing operations were $34 million, and non-controlling interest was $9 million. Stock-based compensation, which is not included in our non-GAAP earnings, was $89 million. Now, I’d like to turn to the changes in our cash and debt. Our total debt at the end of the fourth quarter was $7.37 billion, down $1.14 billion sequentially as we retired the $1.15 billion convertible notes at maturity in early December. Our ending cash position was $1.05 billion, down $2.49 billion due to a combination of the closure of the Marvell assets and the previously noted debt repayment, offset by cash generation during the fourth quarter. The resulting net debt was $6.32 billion, and we exited the quarter with a trailing 12-month adjusted EBITDA of $3.1 billion. Our ratio of net debt to trailing 12-month adjusted EBITDA at the end of the fourth quarter was 2 times, and our non-GAAP interest coverage was 8.9 times. Our liquidity is excellent, and our balance sheet continues to be very strong. During the fourth quarter, we paid $105 million in cash dividends and repurchased $74 million of our shares. Our capital return policy continues to be to return all excess cash to shareholders. Turning to working capital metrics: days of inventory was 102 days, an increase of four days sequentially, which was a result of the Marvell acquisition. We continued to closely manage our distribution channel with inventory in the channel at 2.3 months, within our long-term target, but slightly below the 2.4 months we normally expect to run. Days receivables were 26 days, down 6 days sequentially on improved sales linearity, and days payable were 81, an increase of 7 days versus the prior quarter. Taken together, our cash conversion cycle was 47 days, an improvement of 9 days versus the prior quarter. Cash flow from operations was $814 million and net CapEx was $138 million, resulting in a non-GAAP free cash flow of $676 million. Turning to our expectations for the first quarter. As Kurt mentioned, we anticipate Q1 revenue to be about $2.23 billion, plus or minus about $30 million. At the midpoint, this is up 6% year-on-year, down 3% sequentially. We expect non-GAAP gross margin to be about 53.2%, plus or minus 30 basis points. Operating expenses are expected to be about $573 million, plus or minus about $9 million, and taken together, we see non-GAAP operating margin to be about 27.6%, plus or minus about 20 basis points. We estimate non-GAAP financial expense to be about $78 million and anticipate cash tax related to ongoing operations to be about $32 million. Non-controlling interest will be about $6 million. As for Q1, we suggest that for your modeling purposes you use average share count of 284.5 million shares. Finally, I have a few closing comments I’d like to make. As both Rick and Kurt pointed out, we see the beginning of a moderately improving demand environment across our end markets with the exception of the 5G base station market. From a revenue perspective, we are pleased with our performance in the fourth quarter. Our revenue was slightly better than guidance with contributions from the mobile, auto, and industrial markets all a bit stronger than expected. Our results within the communication infrastructure market were essentially in line with our expectations. Our non-GAAP gross margin has steadily improved over the last year, even as we navigated a challenging top-line demand environment. Our non-GAAP gross margin improved again in the fourth quarter, and as we have previously signaled, we expect to see modest gross margin compression in the first quarter, based on annual price agreements and lower revenue. We continue to be laser-focused on achieving our intermediate non-GAAP gross margin target of 55%, and we believe this can be achieved with the revenue level in the $2.4 billion range. As previously noted, our Board of Directors has approved an additional share repurchase. With the closure of the Marvell deal in December, we began to repurchase shares again in early January and have bought 1.76 million shares at a cost of $230 million between January 2 and February 3. So, with that, I’d now like to turn it back to the operator for your questions.

Thanks for taking my question, and a great job on the free cash flow generation. I think it’s a record result. My first question, on the China impact, I’m curious if your Q1 outlook bakes any supply or demand impact from the ongoing coronavirus related shutdowns, or do you think there could be perhaps a delayed impact on the industry that affects Q2 instead? And if you could remind us of how we think about seasonality for Q2?

So, thanks Vivek. At this time, the situation on the coronavirus continues to be very fluid, and we are monitoring it closely. We’ve taken actions on travel to protect our employees and in our manufacturing operations to ensure that we have our employees at the forefront of our mind, and also been trying to support the general containment of any spread. But, as of today, we’ve seen no impact in orders, although we’re just coming out of the lunar New Year holiday. Clearly, the forced closures by some of the additional provinces in China add more to the uncertainty. And to be clear, it’s just impossible for us to speculate on the impact and implications associated with it. Our guidance today does not contemplate any potential impact from the coronavirus.

All right. And so, my follow-up on gross margins, so Peter, thanks for giving us that $2.4 billion or so level. What will it take, is it just revenue that is the main driver to get to your, the middle of your 53% to 57% target gross margin range, or is there anything about product or end markets or manufacturing costs or competition that is influencing it? Because when I look at your largest market in automotive, things like BMS that you’re working on, most of your competitors are on the analog side, and they’re making 60%, 70% gross margin. So, it seems to me, when I look at 5G or BMS and autos that from that mix perspective, gross margin should be trending in the right direction.

I think there are several factors to consider. First, Q1's number of 53.2 is low compared to Q4's 54.2. The change is primarily due to our annual contractual price agreements, which account for about 60 basis points. Additionally, the decline in volume from Q4 to Q1 is likely another 60 basis points. However, this is balanced by ongoing improvements in processing and manufacturing performance. To increase from 53.2 to 55, we need to raise our revenue to approximately $2.4 billion per quarter. Moving from 55 to 57, which may take several years, will depend on product mix. Our newer products, particularly in the automotive sector and crossover products, will play a significant role. Unlike traditional analog companies that maintain a 65% gross margin with no growth, we aim to significantly exceed market performance. We believe achieving a margin between 53% and 57% is a realistic target. We can reach 55% based on volume, but getting to 57% will likely require a couple more years, hinging on product mix and the launch of our new offerings.

I wanted to follow up again on the gross margin. So, you’re still saying 55% on 2.4, even with the impact of Marvell. Can you give us, I guess, a ballpark estimate of how dilutive Marvell is by itself? And is this maybe the additional wireless to or mobile divestiture that’s offsetting some of that? Like, how do we think about Marvell in the context of that gross margin target?

From a gross margin standpoint, it’s a minor detail. As we previously mentioned, it doesn’t represent a significant portion of our revenue at this stage. We’ve consistently indicated it falls within the low to mid-50s, so it’s just a minor point. I don’t believe it will affect our goal of reaching 55% or $2.4 billion.

And the divested mobile businesses, was that also kind of also closer to corporate average gross margins as well, or was that not?

That’s $150 million of revenue. From memory, it might be a little bit below our regular gross margins, but again, it kind of ends up being a rounding really.

I wanted to follow up on the improvement in demand. You mentioned that the auto and industrial IoT sectors are recovering. Do you believe this reflects genuine end-demand driven by customers, or is it more about balancing inventory? How can you assess what you're observing in the customer channel?

What we’re really seeing, Stacy, is out of China, it’s POS. So, it’s actually shipped through the majority of our business in China is shipped through our distribution partners. But, this is POS where customers have requested business and taken the business. So, it’s not just orders, as far as replenishment of inventory, it’s not possible for us to track what the orders are actually being used for. But, it’s based on their run rates and increased improvements, primarily again focused in micros for the industrial space as well as our automotive business. I’m not sure what the impact or implications, as we said earlier, will be from the coronavirus. But, through just before the lunar New Year, we continue to see strong POS and strong sell-through.

Got it. Thank you very much.

Yes. Good morning, guys. Congratulations on a solid result. Rick, Kurt, it’s nice to see you guys get back to year-over-year growth in the March quarter, even excluding the Marvell acquisition. But my first question is just on the Marvell acquisition. Rick, when you guys announced the deal, you’d put out some pretty, I wouldn’t say aggressive targets, but targets for significant growth of that asset through your distribution business. I know you’ve given specific guidance for the calendar first quarter. But, I wonder if you could just level set everybody on the call as to how you feel about sort of the long-term growth of that Marvell asset and how we should think about the yearly sort of revenue levels to get to that $600 million sort of revenue target you talked about when you first announced the deal.

So, I think we still feel confident about the business. As we talked about, John, it really is about the fact that 60% of our applications processors have connectivity associated with it. So, as we make those reference designs in place, we can provide our own connectivity solutions, which puts us in a good position. The additional distribution feet on the street that we have with the channel, broad channel base we have, we think also positions us quite well. That means that it’s going to be a ramp that will take place as all of that comes to fruition. The $600 million target will clearly be growing at a faster rate at the end of that period than it will be this quarter and next year. We feel good about the business and think all the feedback from customers has been extremely positive about how important it is. I’ll let Kurt make some comments.

Yes. Thanks, Rick. For those who possibly saw us at our booth at CES in Las Vegas a couple of weeks ago, I think we have turned at light speed the availability of the Marvell connectivity assets into reference design. We were able at CES just a couple of weeks, after closing the deal, to show a number of reference designs which included the Wi-Fi product from the former Marvell, into our reference designs for both automotive infotainment connectivity as well as industrial and IoT applications. The interest level and the engagement with customers on that combined solution is as big as we had anticipated.

That’s helpful. And then, as my follow-up, just looking at your auto business in the calendar fourth quarter, only down slightly year-over-year, which relative to peers appears to be significant outperformance. Kurt, I wondered if you could just comment about how the core business performed in the calendar fourth quarter versus kind of the growth segment? And as you look out over the next couple of years with some of the product-specific drivers you have, do you think your growth rate as a multiple of SAAR improves from what it’s historically been?

Thanks, John. Yes, I think our decline rate was only a percentage point, which has significantly improved over the much higher decline rates in the earlier quarters last year. So, absolutely, yes. And clearly, that is a function of what I would say a continued growth of our growth elements, being radar and BMS mainly, and I’d say, a good improvement of the core business, which is very much in line with what we anticipated, given a careful ending of the rationalization of the supply chain. That’s what we said all year long that we would hit that point. That also carries forward into quarter one, which has been reflected in what Rick just said about solid POS trends, especially in China where that core product is a key part of our revenue. Going forward, John, we stick to our model of clearly outgrowing the SAAR based on the content gains of semiconductors. We gave guidance of 7% to 10%, based on a 1% to 2% SAAR. If the SAAR is flattish, well, maybe then we are at 5%, 6%, 7% or so. The ratio between core and growth initially stays the same. Over time, when the growth portion is getting bigger from a relative perspective, it might slightly shift towards higher growth. But, in principle, we are just seeing now what we anticipated, which is that the core is more getting back to normal, given the SAAR coming from a minus 6% environment last year into a probably flattish environment this year.

John, if I could just add that if you look at our automotive business earlier in the year, we had top-tier customers that were actually flat. The significant decline came from the mass market and our distribution partners in automotive. We’re beginning to see the rebound associated with that, where we had such a negative decline.

Hey, great. Thanks for taking my questions, two. First, Rick, I think at some conferences in the last quarter or so, you’ve talked about repurchasing over $2 billion of shares in the coming year. Can you maybe frame that up relative to your expectations for free cash flow in the coming year, your appetite for raising additional debt in order to keep the net leverage at 2 times, and maybe any appetite on the horizon for similar tuck-in acquisitions like Marvell?

I think I’d describe it as follows: First of all, the Board’s authorized $2 billion. So, technically, that wasn’t a forecast of how much we spend in the full year, but we just spent $230 million in basically the first six weeks of this quarter. Once we get started on these things, we don’t tease. What we have said is we will return all excess cash to shareholders, and we will manage our net debt up to 2 times trailing 12 months EBITDA. Depending on your forecast, that requires us to take on a little bit of extra debt to maintain the leverage. I won’t give you an absolute number for the full year because it depends on what you forecast for us. But, I think we’re an exciting company. Once the market comes back, we’ll see significant growth from us that will drive significant cash flow generation, which will be returned to our shareholders.

Regarding the other M&A you asked about, it’s important to realize we’ve been talking about connectivity being a critical element for us for some time. When the Qualcomm transaction broke, we recognized that the missing element we had would be connectivity. The assets from Marvell position us to have leadership in connectivity. We will pursue relatively small tuck-in acquisitions for technology but nothing at the scope and size of Marvell. Our focus will be on returning cash to our shareholders during this period.

That’s really helpful. Thank you. If I can have one follow-up, in automotive, I’m hoping you can frame up the timing of the various growth opportunities. For 2020 and maybe looking into 2021, should we expect the growth to be driven more by the emerging radar solutions, the battery management stuff, or the new network domain controllers? Thanks so much.

This is Kurt. Let me try to stage this a little. From a size perspective, it is less driven by radar, being about 10% of the total auto segment revenue. We continue to absolutely see our midterm growth here with 25% to 30% compound annual revenue growth. That’s the biggest and fastest growing segment. The next one, about similar size, is the digital cluster business, which follows the trends of multi-screen environments in the passenger cabin of modern cars, where we see growth in the mid-teens. The battery management solutions are high-growth, but significantly smaller than the others. It does contribute already to the 2020 and 2021 growth, whereas the S32G, our new fully ASIL D compliant network processor for cars, is launching into the market only in 2021. Thus, from a growth contribution into 2021, it’s at the later end. We are sampling now and getting traction. Additionally, ultra-wideband will also begin to kick in in the second half.

Right. Ultra-wideband will begin to kick in as well in the second half.

Yes. Just to reiterate, our first major use case is actually using ultra-wideband for mobile-based secure car access, which will be significant revenue for us. It will be in mobile but also have further applications in automotive and IoT over the coming years.

Great. So, let me just take this opportunity to thank all of our investors for their support through this difficult semiconductor cycle we’ve been through in 2019. We’re encouraged that we see some initial near-term improvements, specifically in China in sell-through and more stabilization in some of the other regions, which positions us for strong growth going forward from the Company-specific design wins and the portfolio we’ve put in place. We believe this will significantly outgrow the market, and the kind of margin level we’d like to achieve will allow us to generate significant cash that we plan to return to our shareholders. We’re excited about the future and opportunities, albeit somewhat concerned about the impact of the coronavirus, which we have not reflected and don’t know what that impact will be yet. But, we are excited about the opportunities in 2020 and returning to a more normal semiconductor market combined with the Company-specific design wins ramping for us this year. That will allow us to grow at a significant rate. So, thank you very much.

Thank you.