NXP Semiconductors NV (NXPI) — Q4 2020 Earnings Call Transcript

Great. Thank you. Good morning, everyone. Welcome to the NXP Semiconductors' fourth quarter 2020 earnings call. With me on the call today is Kurt Sievers, NXP's President and CEO; and Peter Kelly, our CFO. As mentioned, the call is being recorded today and will be available for replay from our corporate website. Today's call will include forward-looking statements that involve risks and uncertainties that could cause NXP's results to differ materially from management's current expectations, including, but not limited to, statements regarding the continued impact of the COVID-19 pandemic on our business, 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 of 2021. 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. Additionally, we will refer to certain non-GAAP financial measures today which 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 2020 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. Now, I'd like to turn the call over to Kurt.

Yes. Thanks very much, Jeff, and good morning, everyone. We really appreciate you all joining the call this morning. Today, I will review our Q4 and our full-year 2020 performance. I will provide insights on how we view the current supply-demand environment, and I will certainly discuss our guidance for quarter one. Now, let me begin with quarter four. Our results were near the high end of our guidance with the contribution from the Automotive and Mobile markets both meaningfully stronger than planned, and with trends in the Industrial & IoT and communication infrastructure markets in line with our expectations. Taken together, NXP delivered quarter four revenue of $2.5 billion, an increase of 9% year-over-year and $57 million above the midpoint of our guidance range. Our non-GAAP operating margin in quarter four was a strong 30.5%, that is 60 basis points better than the year ago period, and about 80 basis points above the midpoint of our guidance. Our outperformance was thanks to good fall-through on strength revenue growth, thanks to early benefits of our improved factory utilization and solid operating expense control. For the full year, revenue was $8.6 billion, a decline of 3% year-over-year. And as 2020 progressed and the initial impacts of the pandemic earlier in the year subsided, our customers began to accelerate orders at a very robust rate which we do anticipate will continue throughout 2021. Our full year non-GAAP operating margin was 25.9%, a 310 basis points decline due to lower revenue reduced factory loadings combined with slightly reduced operating expenses. It is important to note, however, that throughout the year, we shifted more of our OpEx spend from SG&A towards R&D as we continue to invest in new and differentiated products, which are definitely in the lifeblood of our long-term growth ambitions. Now, let me turn to the specific trends in our focused end markets. Starting with Automotive. Full year revenue was $3.83 billion, down 9% year-on-year, materially better than overall auto production and a reflection of strong new product traction and content gains in ADAS in digital clusters and in electrification which we have always spoken about in the past. For quarter four, Automotive revenue was $1.2 billion, up 9% versus the year ago period and $20 million better than our guidance. Now, moving to Industrial & IoT. Full year revenue was $1.84 billion, 15% year-on-year up with both the wireless connectivity and our crossover processors supporting the growth. For quarter four, Industrial & IoT revenue was $511 million, 23% versus the year ago period, and with that, in line with our guidance. Now, moving to Mobile. Our full year revenue in Mobile was $1.25 billion, up 5% year-on-year. If we are reconciling this for the sale of our voice and audio business during quarter one last year, the underlying Mobile end market growth was up a robust 19% year-on-year. And during the year, we experienced continued strong adoption of our secure mobile wallet and the early ramps of our ultra-wideband solutions, offset by the anticipated discontinuation of some parts of our semi-custom mobile analog interface business. We do estimate the full year attach rate of mobile wallets increased to about 40%, which is in line with our expectations and which is also supportive of our 50% attach rate target exiting 2021. For quarter four, Mobile revenue was $409 million, up 23% versus the year ago period, and with that $40 million better than our guidance. And last but not least, Communication Infrastructure & Other. Full-year revenue was $1.7 billion, down 9% year-over-year. The year-on-year decline was due to reduced sales of RF power products into the cellular base station market relative to the positive trends which we had experienced in the first half of 2019. For quarter four, revenue was $394 million, down 14% year-on-year and in line with our guidance. Now, before turning to our guidance and expectations for the first quarter, I would like to offer my view on the current demand and supply environment as it pertains to NXP. When our customers began to reopen after the shutdowns in the second quarter, we did see order rates through Q3 and Q4 accelerate at a very rapid rate. This trend has continued and it will likely be the case over several quarters to come. The increased demand has been broad-based across most of our focused end markets, most of our product portfolio and all of our geographies, as well as across our direct and our distribution fulfillment channels. We actually believe that the working from home trends because of the pandemic, which emerged in full force beginning in the first half of the year led to an explosion in demand for high volume consumer compute and mobile type products in the industry. And then, as the auto and industrial markets begin to rebound in the second half of the year, the available foundry capacity was largely sold out. As a result, we and others are experiencing significant increases in lead times, and in certain cases, increased costs from suppliers. Taken that altogether, the setup indicates a really robust demand environment combined with a very challenging supply situation, which we anticipate may continue for several more quarters, and we are working very diligently with both our external suppliers, our internal operations team and our customers to adequately align supply with demand. Against this backdrop, now let me come to the quarter one guidance. We are guiding quarter one revenue at $2.55 billion, up about 26% versus the first quarter of 2020 within the range of up 22% to up 30% year-over-year. From a sequential basis, this represents growth of about 2% at the midpoint versus the prior quarter. At the midpoint, we anticipate the following trends in our business. First, Automotive is expected to be up in the mid-20% range versus quarter one 2020, and up in the mid-single digits versus quarter four 2020. Industrial & IoT is expected to be up nearly 50% year-over-year and up high single digits versus quarter four 2020. Mobile is expected to be up 40% year-over-year and down in the mid-teens versus quarter four '20. And finally Communication Infrastructure & Other is expected to be flat versus the same period a year ago and up in the low single digit range on a sequential basis. Now, while we are really encouraged by the rapid rebound in demand, it is important to remember, we are still challenged by the impact of the global pandemic, and we will carefully navigate the improving demand environment focused on meeting our customers' requirements while simultaneously assuring at all times the safety and health of all of our employees, and I am extremely proud of their adaptability, their dedication and their hard work in the face of continued adversity. So in summary, customer engagement levels, our design win momentum and our strategic focus areas continue to be all very positive, and hence we continue to be very optimistic about the future potential of NXP. And with that, I would like to pass the call to you, Peter, for a review of our financial performance.

Thank you, Kurt. Good morning to everyone on today's call. As Kurt has already covered the drivers of the revenue during the fourth quarter and provided our revenue outlook for Q1, I'll move on to the financial highlights. Overall, our fourth quarter financial performance was very good. Revenue was near the high end of our guidance range with an improvement of both non-GAAP gross profit and non-GAAP operating profit. I'll first provide full year highlights and then move on to the fourth quarter results. Full year revenue for 2020 was $8.61 billion, down 3% year-on-year. We generated $4.4 billion in non-GAAP gross profit and reported a non-GAAP gross profit margin of 51.1%, down 240 basis points year-on-year because of the significant deceleration of revenue and the associated lower factory utilization during the year. Total non-GAAP operating expenses were $2.17 billion, down $8 million year-on-year. Total non-GAAP operating profit was $2.23 billion and non-GAAP operating margin was 25.9%, down 310 basis points year-on-year. Non-GAAP interest expense was $357 million, cash taxes for ongoing operations were $103 million, and incidental taxes were $45 million with non-controlling interests of $28 million. Stock-based compensation, which is not included in our non-GAAP earnings was $384 million. Full year cash flow highlights include $2.48 billion in cash flow from operations and $388 million in net CapEx investments resulting in $2.09 billion of non-GAAP free cash flow, or a very healthy 24% of revenue. During 2020, we repurchased $627 million of shares and paid cash dividends of $420 million. In total, we returned $1.05 billion to our owners, which was 50% of the total non-GAAP free cash flow generated during the year. Now, moving to the details of the fourth quarter. Total revenue was $2.51 billion, up 9% year-on-year at the high end of our guidance range. We generated $1.3 billion in non-GAAP gross profit and reported a non-GAAP gross margin of 52.9%, down 130 basis points year-on-year, modestly above the midpoint of guidance. Total non-GAAP operating expenses were $563 million flat year-on-year and up $13 million from Q3 in line with the midpoint of our guidance. From a total operating profit perspective, non-GAAP operating profit was $764 million and non-GAAP operating margin was 30.5%, up 60 basis points year-on-year and well above the high end of our guidance. Non-GAAP interest expense was $90 million, cash taxes for ongoing operations were $30 million and non-controlling interest was $11 million. Stock-based compensation, which is not included in our non-GAAP earnings was $89 million. So, turning to the changes in our cash and debt. Our total debt at the end of Q4 was $7.61 billion, down $1.75 billion sequentially, as we retired early the 2021 $1.35 billion, 4.125%, and the 2022 $400 million, 4.625% notes. We did this on September 28th, which is the first day of our fourth quarter. Our ending cash position was $2.28 billion and was down $1.29 billion sequentially, mainly due to the previously noted debt repayments, offset by cash generation during the fourth quarter. The resulting net debt was $5.33 billion, and we exited the quarter with a trailing 12-month adjusted EBITDA of $2.79 billion. Our ratio of net debt to trailing 12-month adjusted EBITDA at the end of Q4 was 1.9 times and our 12-month adjusted EBITDA interest coverage was 8 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 $257 million of our shares. Turning to working capital metrics, days of inventory was 78 days, a decrease of six days sequentially, significantly below our long-term target. We continue to closely manage our distribution channel with inventory in the channel at 1.6 months, also below our long-term targets. Both metrics reflect customer orders accelerating faster than we've anticipated and we find ourselves in a supply constrained position. It will take a number of quarters to rebuild on-hand inventory and channel inventories to our long-term target levels. Days receivables were 28 days, down two sequentially, and days payable was 75, an increase of 20 days versus the prior quarter as we rapidly increased material orders with our suppliers. Taken together, our cash conversion cycle was 31 days, an improvement of 28 days versus the prior quarter, reflecting strong customer demand, solid receivables collections and positioning for customer deliveries in future periods. Cash flow from operations was $1.03 billion in the quarter and net CapEx was $103 million, resulting in a non-GAAP free cash flow of $926 million. Turning to our expectations for the first quarter, as Kurt mentioned, we anticipate Q1 revenue to be about $2.55 billion plus or minus about $75 million. At the midpoint, this is up 26% year-on-year and 2% sequentially. We expect non-GAAP gross margin to be about 53.5% plus or minus 30 basis points. Operating expenses are expected to be about $590 million plus or minus about $10 million. Taken together, we see non-GAAP operating margin to be about 30.4% at the midpoint. We estimate non-GAAP financial expense to be about $85 million and anticipated cash tax related to ongoing operations to be about $56 million. Non-controlling interest will be about $10 million, and for the first quarter we suggest that for modeling purposes we use an average share count of 284 million shares. Finally, I have a few closing comments I'd like to make. One, clearly demand has come back more rapidly than we could have expected. Our current focus is to look after our customers and ensure we ship as many products to them as possible. It's unfortunate that some of our suppliers are attempting to use the current tight supply environment as a short-term opportunity to raise prices, which we will clearly have to pass on. To be clear though, we do not see this as an opportunity to improve our margin by sacrificing long-term relationships. Additionally, given the tightness in supply and the level of orders, we anticipate shipping for production during Q1. It's unlikely we'll be able to increase our months of supply at distributors or move our DIO target upward towards our long-term targets during the first quarter. Between January 4th and February 1st, we bought back an additional $354 million worth of stock, and plan to continue to buy back in line with our capital allocation policy of returning all excess cash to shareholders. Clearly, our operating margin reflects the significant fall-through benefit of the additional revenue. Although the current environment creates a new set of challenges, we believe we can still deliver on our margin improvement plan in 2021. In terms of the pandemic, our team continues to perform in a truly outstanding way. And the safety of our team members, as Kurt mentioned, continues to be our primary concern. If anyone experiences any symptoms or in any way exposed to the virus, we ask them to self-isolate for a period. Unfortunately, in Q4, we've seen a few more people unexpectedly in our fab operations requiring to self-isolate, and as a result of the shortage of labor, a small impact in our internal fab output. Although this causes a short-term issue, it's clearly best for our overall performance in both the short and medium-term. We estimate this is impacting us to the tune of 80 basis points of profit in Q1 and 40 basis points will impact us in Q2. While this is a short-term headwind, the safety of our employees remains our key consideration and we believe our COVID protocols are appropriate and correct. Finally, I'd like to thank all my colleagues at NXP for a truly amazing 2020. You've done an incredible job in a truly unbelievable environment and set us up for a very bright future. So with that, I'll turn it back to the operator for your questions.

Yes, good morning, good afternoon, and thank you for taking the question. I guess, first question, on gross margins, Peter, you talked about the 55% still clearly in play. Curious if you can speak to how utilization will play a role in that, how mix assuming comps recovers through the year? And then, I guess, probably most importantly, how to think about rising input costs and your ability to pass on and whether there is a timing difference there?

Thank you for the great questions. Let's address the transition from Q4 to Q1 first. In Q1, we see an increase from 52.9% to 53.5%. I mentioned last quarter that utilization would affect us by about 150 basis points in Q4, implying we would benefit from that in Q1. However, due to self-isolation needs, we only realized about 70 basis points of improvement from Q4 to Q1. The increase from 52.9% to 53.5% comprises three main factors: a 70 basis point improvement from factory performance, an additional 20 basis points from unexpected factory performance, and a 30 basis point headwind from our annual price reductions. Moving from Q4, where we achieved 53.5%, to the question of why we're not reaching 55%, the missing 150 basis points attributes to two factors. There is roughly 50 basis points of underutilization and about 100 basis points related to mix, particularly in our communications infrastructure business, which is weaker in the first half compared to strong performance in auto and mobile. We anticipate that as the year progresses and 5G advances, our mix will improve. Regarding pricing, it's mixed. While some suppliers are attempting to raise prices, we also have long-term contracts with many suppliers, similar to our agreements with customers. Although it's a mixed situation, we are witnessing price increases and will strive to pass those on to our customers. It’s worth noting that this process might not be immediate; we might face delays of a month or two, or even a quarter, in passing on these increases. We want to emphasize that the current environment is not viewed as an opportunity for structural margin improvement. We operate as a commodity business and do not adjust pricing based on market conditions. Did I cover everything?

Yes, Peter. Yes. No, that was great. And I guess, Kurt, if I could just follow up with a quick question, considering the supply constraints on the auto side and considering your and NXP's focus are really providing complete solutions, curious about what impact kind of the current supply constrained environment is having on your level of engagement with your automotive customers?

Yes. Hi, C.J. So I think actually, and that might sound ironic, but that's not what I mean. It actually improves the engagement because I have probably never spend so much time with our customers as of today. And while certainly this is a challenging moment for everybody in the chain, there is a lot we speak about the future in terms of how do we best deal with this on a go forward basis because everybody recognizes the enormous relevance of semiconductors in building cars. So thinking about trends, thinking about aligning forecasts on a more mature basis is definitely a positive result out of this. So, I don't think this is a negative. I think it is actually something we as an industry altogether are learning from how to avoid these things from happening in the future. And the way to do this is just a much closer collaboration than we've had along the chain. And what I mean is really not only with our Tier 1 customers, but also with the OEMs directly. And that is obviously great for innovation at the same time.

Hi, guys. Thanks for taking my questions. So my first question, I wanted to ask about the trajectory for the year. I mean, like normally Q1 is the trough of the year, usually down, well, I don't know, 7% or 8% sequentially from Q4 to Q1, you're obviously up a little bit this time. Given your commentary on sort of like sustained demand through the year, do you still see Q1 potentially is the trough?

Hi, Stacey. You are suggesting a seasonal aspect. However, in the current context, traditional seasonal patterns may not apply. This is indeed a strong Q1 compared to historical trends, but we must remember that we are emerging from two challenging years. While many discuss the pandemic's effect on 2020, it's important to note that 2019 was also weak in the semiconductor sector. From this viewpoint, we are truly coming out of a prolonged downturn, which aligns with my earlier comments in the prepared remarks. We anticipate a robust demand environment throughout the year, extending beyond Q1.

Thank you. I would like to follow up on Peter's comment about your confidence in achieving your margin improvement plan for 2021. Could you clarify what that margin improvement plan entails? Is it the target of 55% gross margin, or could you specify what you mean by delivering on your margin improvement plan in 2021?

55%.

Okay. Is the revenue still at the $2.4 billion level, or do you see yourself maintaining it?

I think the levels of business we are at the moment, we should be running at about 55%. I mean we think it will get a little bit carried away, because it's not many dollars that moves that 50 basis points either way.

Yes, I get that. Do you have any idea when in the year you might hit it tough, is that like a second half kind of target or...

I think it's definitely second half, Stacy. And one of the single biggest items is our comm infra being a bigger percentage of our overall business than it is today.

Okay, got it. But without the COVID impact, you would be running over 54% right now in Q1, correct?

Yes, yes. I think so, yes.

Got it. Okay, thank you, guys. Appreciate it.

Thank you for answering my question, and congratulations on the strong growth and execution. Kurt, I'm interested in your baseline outlook for automotive unit growth in 2021 as we start the year. Additionally, last year your auto semiconductor sales decreased by 9, yet they were ahead of auto units by about 5 to 7 points, which was quite impressive. How should we expect a similar content delta this year? I'm asking these questions because it seems the industry has had a robust start, but can this level of strength be sustained? I would appreciate any guidance on what our expectations for unit and content growth should be this year.

Yes, sure, Vivek. Let me start with what IHS is telling us. For this year, they project around 85 million units for auto, which would represent a 14% year-on-year growth in units. IHS figures have always been our internal point of reference. In my frequent discussions over the past few weeks and at the end of last year, I've sensed that sentiment in the auto industry might be even more optimistic, perhaps estimating between 85 million to 90 million units that car companies aim to achieve. Much of this is based on the assumption that by the second half of the year, society will be fully vaccinated and return to more normal conditions, providing a boost to auto production and sales. While the 85 million unit forecast indicates a 14% growth, you are also pointing to the content aspect of this discussion. Our faster growth, which was 7 points above the SAR last year, is attributed to growth in content and our focus on high-growth areas such as radar, electrification BMS, and digital clusters, which did not decline. These segments, making up about a quarter of our auto business, actually experienced growth even in a year when the SAR dropped by approximately 16%. We expect this content growth to continue at the same rate going forward. A crucial factor is the CO2 targets that frequently lead to more electrification. However, this isn't limited to electric engines; there are numerous other applications aligning with electrification that are significantly increasing the semiconductor content in vehicles. Overall, I believe it is reasonable to expect 85 million units for this year, which translates to a 14% growth for SAR. Importantly, our prediction of outpacing the SAR remains strong this year. Another aspect everyone's keen to understand is the inventory levels. Currently, it appears that supply chains in the automotive sector are quite empty. I can confirm this because we see that every single product we ship is immediately integrated into vehicles, leaving nothing on the sidelines. This is why we have clearly stated that we are supply constrained for the first quarter. Consequently, I've heard many in the industry express the need for more inventory throughout the automotive supply chain moving forward. One major U.S. OEM even publicly stated its desire for increased chip inventory at its first-tier customers. If we combine this with the content gains and the SAR growth previously mentioned, I believe there is a strong basis to anticipate a sustained growth pattern over multiple quarters.

Got it. Very helpful. And for my follow-up, maybe Peter one for you, you mentioned that the plan is to return all excess free cash flow to investors. Last year you generated over 2 billion or so in free cash flow. And I think the dividend only takes a quarter of that. How should we think about buybacks this year? I know you gave a number for the start of the year. Should we assume that based on the expectation of stronger free cash flow that most of it will be devoted to buyback, so we could be back in some of the strength we have seen in some prior years or do you still expect to use some of that to delever the balance sheet further? Thank you.

Okay. Vivek, we've been amazingly predictable. Okay. So our stated capital allocation policy is we will return all excess cash to shareholders up to a level of 2 times net debt to trailing 12 months EBITDA. The reason we didn't return even more in 2020 is because for most of the year we were above 2 times net debt to EBITDA with the weak performance in Q2. So depending on what your model is, you should assume that all excess cash up to a level of 2 times net debt that's returned to shareholders. So, yes, it will be substantially higher in 2021 than it was in 2020. Same way 2019 was substantially higher than 2020, and we definitely would not use it to delever the balance sheet.

Got it. And you're already at 1.9. So you are below that range right now?

The difference between 1.9 and 2 is not a big number.

Yes. Good morning, Kurt; good morning, Peter. Congratulations on the solid results. Kurt, my first question is on the comms infrastructure business, given how important it is to mix in gross margin leverage as we go throughout the year, what's the visibility in that business? Why do you think it recovers in the back half of the year? Is this a view that the U.S. government's stance on Huawei changes or do you see other design wins with other OEMs that will drive that business throughout the year?

Thank you, John. I want to address the situation with Huawei first. We are taking a conservative approach and do not expect any changes regarding licensing with Huawei, so that is not part of our plans. Our optimism for the second half of the year is primarily based on our product portfolio. We previously mentioned our gallium nitride technology, both in terms of the products and our production capabilities, which started to come online at the end of last quarter. All of our products are now qualified, particularly with a select group of significant customers. Since gallium nitride is new to us and we haven't previously had this capability, we are confident that we will gain market share with the continued expansion of infrastructure in the upcoming year. We anticipate that growth will be more pronounced in the latter half of the year compared to the first half, driven primarily by the penetration of gallium nitride technology that we expect to see.

Well, I mean we only guide the first quarter here, John. So I will not provide guidance for the full year in mobile. But certainly our focus on further driving penetration with the mobile wallet, where I think I spoke about the hitting the 40% attachment rate at the end of last year, and we think we are perfectly on track to get this to a 50% rate through this year. And secondly, we have the emerging ultra-wideband, and you've probably followed the most recent announcements of Samsung, who actually brought now another couple of phones out which are carrying ultra-wideband, and that is now also spreading into associated ecosystems, which I think makes it even more attractive. I think Samsung spoke about digital car keys for a couple of car companies, and they also spoke about actually their first move now into the IoT world, which is a product which they call the Smart Tag Plus which is like a small finder device, which you can attach to something, and then you will find it with your phone. Now, all of that is going to help with Samsung, but of course also with the other OEMs, drive further and speedy ultra-wideband adoption in line with what we did in the Investor Teach-In some time ago. So those two pillars are standing firm, and I'd say certainly some of the big OEM customers also have good run rates, John, but I would say for us, it continues to be a content growth story. Secure mobile wallet, secure ultra-wideband, and then you know, we also had the eUICC which is coming in, so there is a number of very specific content drivers which make us actually quite optimistic in mobile on a continued basis beyond the unit rate.

And Kurt, do you have enough data yet to think about how your content trends from 4G to 5G? I'm assuming that these new applications are more broadly adopted in 5G firms.

Yes. Sorry, I didn't respond to this in the first place. I think actually in principle this is not dependent or required as an association with 4G or 5G, specifically. Clearly, 5G will be about high-end phones in the first place, where the early adoption of these features might be first. But it is not necessarily something which is dependent on 4G or 5G, so which is good actually. So, we are kind of agnostic to that.

Hi, guys. Thanks for letting me ask the question. First, Peter, congratulations on your retirement announcement. I know you're going to be with us for another year or so, but congrats nonetheless.

Thanks, Ross.

I guess, just my first question, overall, everybody knows that there are supply shortages, but I hope to get a little more color on it from a somewhat higher level. Could you size in any way, shape or form the impact on what you couldn't ship, and so what your revenue impact of the supply constraint was in the fourth quarter, the first quarter? Any color about which end market is more acutely hit as you split your business? And then in the timing wise, when do you think you'll be able to catch up?

I would say a couple of things, Ross. You can expect significant numbers in the fourth and first quarters if you adjust our calculations for months of inventory and distribution, but I’m not certain how relevant that really is. In theory, we could have shipped hundreds of millions of dollars more, but I’m unsure how much of that would have come from Q3 and Q4. We’re observing strength across our businesses. The automotive sector is particularly reporting more issues due to real supply problems and potential factory shutdowns, which is different from the smaller customers who may not have the same visibility. However, even those smaller areas are experiencing challenges. It's quite widespread, and recalling Kurt’s comment about 2019, the supply chain was really depleted then, with weak demand. We’ve somewhat sidelined 2019 in light of COVID, and in the first half of 2020, we faced similar issues. So we're seeing near-empty supply chains overall. This situation is somewhat worsened by the movement towards larger Taiwanese foundries outside of China, as people are concerned about sourcing products from China. It's tough to attribute this to specific circumstances. In theory, we could have shipped much more. We are essentially sold out for Q1. We're investing considerable time with customers to ensure their factories remain operational, which is why Kurt mentioned that we believe what we’re currently shipping isn’t adding to inventory. We think it’s all going towards product building, and it will likely be a while before balance is restored. We wouldn't speculate on when that point will be, but we hope everyone will be able to operate more normally then.

Thank you for that information, Peter. Now shifting focus to operating expenses, you provided a lot of insights regarding gross margin and profitability, explaining the current situation and potential improvements. How are you managing the operating expenses? It seems like revenue is expected to be very robust this year. Will you be aligning your spending with that? How should we consider the $590 million figure from the first quarter in terms of trends for the remainder of the year?

We aim to allocate 16% of revenue for R&D and 7% for SG&A. The increase in dollars from Q4 to Q1 is primarily due to non-executive variable compensation, which is essentially incentive-based. We're monitoring operating expenses closely and will not spend ahead of revenue. In the short term for Q1, the increases are all related to variable compensation accruals.

Okay. Thank you.

Great, thanks for taking my question. I'm wondering if you can discuss the competitive landscape today a little bit, in particular as it relates to pending M&A. You have ADI buying Maxim that consolidates the analog market a little bit. You have Nvidia buying Arm, which is an important supplier of yours. I'm wondering if you can comment as to whether either one of these or any other transaction might have any influence on your competitive positioning and perhaps your own plans from the perspective of consolidation?

Hi, Bill. We typically do not comment on mergers and acquisitions during these calls. However, what's important to note is that regarding our strategic focus and our strong belief in our ability to differentiate ourselves, we remain very confident in the portfolio we have developed, which has been significantly shaped by our M&A efforts. The trends we see in secure edge processing solutions stem from the acquisition we made a few years ago with Free Scale, further enhanced by our wireless acquisition from Marvell about a year ago. We are proud of our successful integration of these assets, which now allow us to launch new products and solutions leveraging the intellectual property from these previous deals. Based on what I know about the transactions you mentioned, we do not perceive them as a threat to our competitive position. While I refrain from commenting on M&A in general, I want to emphasize that it does not undermine our trust and confidence in our strategic focus. I firmly believe that our dedicated execution on our current initiatives holds significant value.

Great, appreciate that. And maybe if I can follow up with another question about the supply-demand imbalance, typically when this happens, you have this behavior of over-ordering by some customers that stimulates capacity additions, and sort of there goes the cycle. This behavior is typically what sort of paints the peak of the cycle. I've argued that I think that the lean inventory through the supply chain and really the breadth of demand, what perhaps will make this cycle extend a little bit longer, but I wonder if there's anything else that relates to the insight that you've all shared with us already suggesting that we continue to see this imbalance favoring growth as we go through the year?

Yes, I completely agree that we have seen these situations before. There is certainly an element that could lead to a bubble eventually. However, I want to emphasize, based on my practical experience, that everything we ship is going straight into production without accumulating any inventory. It’s important to note that while there is a lot of focus on the automotive sector, as mentioned by Peter, this demand surge extends to our other markets as well. This leads me to believe that, for the moment, we are not in a phase of building up inventory. Of course, we will monitor this situation closely because we have experienced it in the past and have the necessary controls in place, but now is not the time for concern. We clearly anticipate that this demand will continue for several quarters without unnecessary inventory buildup. The only aspect I would highlight, which could evolve into a growth trend, is that the automotive industry might prefer to maintain higher inventory levels throughout the supply chain as a lesson learned from recent challenges, aiming to avoid future disruptions. This would be a strategic decision to build inventory rather than a bubble, and while we aren't there yet, it could materialize later in the year.

Great. Thank you.

Thanks for taking my question. I just want to ask on the Industrial & IoT business, we obviously talked about the auto segment in depth. Obviously in that business, seasonality is typically down. You guided it up. I think have an easy year-over-year compare, but it still seems up pretty robustly. So maybe just talk about the drivers within that segment?

Blayne, did I hear you right? Industrial & IoT? Is that what you asked?

Yes.

Yes. Now, absolutely, I mean we are actually quite proud about our performance in Industrial, since even last year, which clearly was a very difficult year for the industry, our industrial business on a full-year basis did grow by 15% year-on-year. And as you've seen from the guide, we have the confidence, we continue this. It's really carried by the solution capability made up by the cross-over processors. I mean, it's the whole processing portfolio, but specifically the cross-overs are delivering on the promise coupled with our WiFi capabilities. And you might have seen just in Q4, we launched our first, and what I think is really an industry-leading 2x2 Wi-Fi 6 solution, which is a result of the Marvell acquisition. But getting this altogether into solutions is actually doing what we wanted to see. Now there is one other element with this, which I think is a driver for the growth for NXP particularly in that segment and that is our exposure to China. That's also I think the background for last year's strong performance because China left the pandemic from an industrial performance perspective behind them already in the second quarter. So, if you will, China had three strong quarters last year, and our industrial business has a quite big exposure to China. So we've been benefiting from this and we see this continuing into this year.

Thank you. And maybe as a follow-up to that, could you just talk on the supply side? Is this a segment that you're also being impacted by tightness, and any kind of view on kind of lead times within that segment?

It's across the Board, Blayne. So yes, we are also impacted by the tightness of supply in our Industrial business. I can't really talk about lead times, because it really differ. I mean we have a number of products with very normal lead times, but we also have a couple of products with 52 weeks lead time. So there is not one answer to this question. The only thing I can say is that, yes, Industrial is also impacted by the tightness of supply.

Tiffany, I think that would be our last call, maybe pass it over to Kurt.

Yes. Thanks very much, operator. Yes, I think, in summary, it is fair to say that if we just for a minute look back to last year, last year has really been a year with two phases; a very grim and very difficult year in the first half, and then a definitely faster than anticipated recovery in the second half. And given all the discussions which we've had about supply and demand, it is fair to say that we believe it's only the start of the recovery. This will continue through the calendar year 2021 and we see that our specific end market focus of NXP with a lot of strength in Automotive, with a lot of very specific strength in the Mobile and in Industrial & IoT gives us actually a very good opportunity to benefit from this continuing recovery into this calendar year. The one segment we've certainly been less happy with is the comms infra segment, as we discussed, but also there, given the new product introductions in gallium nitride, we are optimistic on the second half of the year, which is a strong driver for our mix when you think about our margin targets. And with that, I thank you all for dialing into the call, and most of all, please all stay safe and stay healthy. Thank you very much.

Thank you.