NXP Semiconductors NV (NXPI) — Q1 2021 Earnings Call Transcript

Thank you, Ron, and good morning, everyone. Welcome to the NXP Semiconductors first quarter 2021 earnings call. With me on the call today is Kurt Sievers, NXP's President and CEO; and Peter Kelly, our CFO. The call today is being recorded 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. These risks and uncertainties include, but are 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 second quarter of 2021. Please be reminded that NXP undertakes no obligation to revise or update publicly any forward-looking statements. For a full disclosure of forward-looking statements, please refer to our press release today. Additionally, we'll refer to certain non-GAAP financial measures, which are driven primarily by discrete events and 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 first quarter 2021 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 Kurt. Kurt, your call.

Yes. Thanks very, very much, Jeff, and good morning, everyone. We really appreciate you joining our call today. Today, I will review our quarter one results and discuss our guidance for Q2. Furthermore, I will provide an updated perspective on how we view the current supply-demand environment, including the recovery of our two Austin-based facilities, which were hit by the severe winter storm in February. Additionally, I will discuss our efforts for sustainability. Now let me get started with quarter one. Our results were better than the midpoint of our guidance, with the contribution from the industrial and the communication infrastructure end markets, both stronger than planned. At the same time, trends in the Mobile and Auto markets were generally in line with our expectations, with Automotive being just slightly impacted by the severe winter storms in Texas. Taken together, NXP delivered quarter one revenue of $2.57 billion, an increase of 27% year-over-year and $17 million above the midpoint of our guidance range. Non-GAAP operating margin in Q1 was a strong 30.9%, 600 basis points better than the year-ago period, and about 50 basis points above the midpoint of guidance, driven both by improved mix and additional revenue. Now let me turn to the specific trends in our focus end markets. In Automotive, quarter one revenue was $1.23 billion, up 24% versus the year-ago period and about $13 million below our guidance. In Industrial & IoT, our quarter one revenue was $571 million, up 52% versus the year-ago period, and about $13 million better than our guidance. In Mobile, quarter one revenue was $346 million, up 40% versus the year-ago period and in line with our guidance. Reconciling for the sale of the voice and audio business, which closed during quarter one 2020, the underlying mobile end market growth was actually up a robust 46% year-over-year. Lastly, in Communication Infrastructure & Other, quarter one revenue was $421 million, up 4% year-on-year and about $17 million better than our guidance. Now, let me move to our outlook. We are guiding quarter two revenue at $2.57 billion, up about 40% versus the second quarter of 2020 within a range of up 38% to up 45% year-over-year. From a sequential perspective, this is about flat at the midpoint versus the prior quarter. At the midpoint, we anticipate the following trends in our business. Automotive is expected to be up in the upper 80% range versus quarter two 2020 and up in the low single digits versus quarter one 2021. Industrial & IoT is expected to be up in the low 30% range year-over-year and flat versus quarter one 2021. Mobile is expected to be up in the mid-30% range and flat versus quarter one 2021. Finally, Communication Infrastructure & Other is expected to be down in the low-teens percentage range versus the same period a year ago and down in the mid-single-digit range on a sequential basis. Now at this point, let me turn to an update on the current supply/demand environment. As I shared with you on our last earnings call, as many of our customers started to resume full production during Q3 of 2020, we were faced with the challenge to balance a very accelerated rate of customer orders versus a very tight, if not sold out wafer supply situation. While our foundry partners have attempted to address our needs, it really has not been enough, and we were supply constrained in quarter one. This supply trend will continue through quarter two, and our current expectation is we will face a tight supply environment for at least the remainder of 2021. We also note that in the medium-term, we have seen a significant increase in demand for our products, which is very consistent with our anticipated content gains and our design wins. In that very context, it is really insightful to compare to the pre-pandemic levels of 2019. When we look at total current revenue levels compared to the pre-pandemic levels in 2019, we actually plan to ship nearly 20% more in the first half of 2021 versus the first half of 2019. More specifically, in automotive, we plan to ship at least 20% more in the first half of 2021 versus the first half of 2019. This is while IHS suggests a drop of 10% in car production over the very same period. And now going forward, we see our overall revenue in the second half of 2021 being stronger than the first half of this year. Against these trends, we continue to have low channel and low on-hand inventory, which we do not anticipate rebuilding this year. Our customers are responding by placing long-dated, non-cancelable and non-returnable order requests. We are making long-term strategic supply commitments to our partners to assure future supply. Against this challenging supply environment, we also had the unfortunate and unexpected winter storms in Austin. I am today pleased to share that our two wafer facilities in Austin are now fully back online. I would like to commend our manufacturing, our operations, and our facilities teams for their superb effort and dedication to getting these two facilities back online in record time. Truly a job very well done. Notwithstanding the challenging supply environment or the natural disasters we faced, our results and guidance clearly validate the underlying long-term growth and profitability of our business. We acknowledge it has been a long process to deliver on our committed gross margin target. The next objective will be to demonstrate full-year performance at the 55% gross margin target. Furthermore, on a positive note of recognition, NXP was added to the S&P 500 Index, which is a strong validation of a lot of hard work the entire NXP team has undertaken to drive growth, improve profitability, and enhance free cash flow. Now before I pass the call over to Peter, I would like to take a minute to discuss our sustainability efforts, an area to which NXP has a long demonstrated history of commitment. At a more personal level, I believe sustainability is a very important journey. We all need to embrace and undertake. It's not just a finite destination. At NXP, we are dedicated to our long-term sustainability goals, which our employees, our customers, our suppliers, and investors all believe are of the utmost importance. All our stakeholders are paying attention to the products we develop, how our company complements the communities we operate within, and how we attempt to lessen our impact on the environment. Recently, we published our annual Corporate Sustainability Report in our annual proxy statement, both of which set forth the progress we have achieved towards previously stated goals and lay out our vision for the future. In support of our continuous commitment to improve our environmental and social responsibility and our corporate governance metrics, there are a few areas I would like to highlight, starting with social responsibility. We have made clear our commitments to workplace diversity, equality, and inclusion. In order to ensure our working environment provides equal access and opportunity, we appointed a Head of Diversity, Equality, and Inclusion, reporting directly to me and to our Executive Vice President of Human Resources. We are dedicated to creating an inclusive and diverse work environment where NXP appropriately mirrors the society and communities in which we operate. We have an ongoing commitment to improve and refine our corporate governance. In 2020, we enhanced our human capital management disclosures, which expanded and detailed workforce demographics. We are committed to improving gender diversity throughout the organization, especially within the company's leadership teams. Now, turning to environmental impact. In 2020, we met our 10-year goal of reducing our carbon footprint by 30%. We achieved a 47% water recycling rate, and we purchased 27% of our electricity from renewable sources, led by our factory in Nijmegen, which is running 100% on renewable energy. Finally, and certainly not least, our employees. We believe our employees are the lifeblood of innovation and the spirit at NXP. We are dedicated to building a highly engaged workforce who will continuously push the boundaries of innovation. We view a highly engaged workforce as the very best early indicator of potential success for our company in the future. We measure this annually through a global employee survey called the winning culture survey. That survey looks at multiple early indicators of long-term employee engagement, including factors such as employee views on company strategy, innovation, execution, and leadership, as well as culture, collaboration, and a supportive work environment. I’m proud to say that in 2020, we had a 90%-plus global participation rate. Now, in summary, we are very encouraged by the rapid rebound in demand across our end markets. Based on our customer conversations and order rates, it appears NXP is in the early stages of a longer-term company-specific growth cycle. Our employees are highly engaged to drive our success; we have a robust pipeline of new and innovative products; and customer response engagement and design win momentum all underpin our optimism about NXP's future potential. I'm extremely proud of all our employees, but today, I would like to specifically commend our manufacturing, our operations, and customer-facing teams for their relentless focus and energy while assuring customer success. Their dedication and hard work in the face of a challenging supply environment truly make a big difference. Now, I would like to pass the call to Peter for a review of our financial performance. Peter?

Thank you, Kurt, and good morning to everyone on today's call. As Kurt has already covered the drivers of the revenue during the first quarter and provided our revenue outlook for the second quarter, I'll move on to the financial highlights. Overall, our first quarter financial performance was very good. Revenue was above the midpoint of our guidance range, and we drove an improvement of both non-GAAP profit and non-GAAP operating profit. Moving to the details of the first quarter. Total revenue was $2.57 billion, up 27% year-on-year and above the midpoint of our guidance range. We generated $1.39 billion in non-GAAP gross profit and reported a non-GAAP gross margin of 54.2%, up 240 basis points year-on-year and above the high end of our guidance. Total non-GAAP operating expenses were $600 million, up $55 million year-on-year and up $37 million from the fourth quarter. This was $10 million above the midpoint of our guidance due to increased variable compensation, driven by an improved first-half performance. From a total operating profit perspective, non-GAAP operating profit was $792 million, and non-GAAP operating margin was 30.9%, up 600 basis points year-on-year and was at the high end of our guidance. Non-GAAP interest expense was $87 million; cash taxes for ongoing operations were $40 million, and non-controlling interest was $11 million; taken together, $13 million better than our guidance. Stock-based comp, which is not included in our non-GAAP earnings, was $91 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 $7.61 billion, essentially flat versus the fourth quarter. Our ending cash position was $1.84 billion, down $433 million sequentially, mainly due to share repurchases, offset by cash generation during the first quarter. The resulting net debt was $5.77 billion, and we exited the quarter with a trailing 12-month adjusted EBITDA of $3.09 billion. Our ratio of net debt to trailing 12-month adjusted EBITDA at the end of quarter 1 was 1.9x, and our 12-month adjusted EBITDA interest coverage was 8.6x. Our liquidity is excellent and our balance sheet continues to be very strong. During the first quarter, we paid $105 million in cash dividends and repurchased $905 million of our shares, totaling $1 billion of capital returned to our owners during the quarter. Turning to working capital metrics, days of inventory was 81 days, an increase of 3 days sequentially, and continues to be significantly below our long-term target of 95 days. We continue to closely manage our distribution channel with inventory in the channel at 1.6 months, flat sequentially and below our long-term target. Both metrics reflect the continuation of strong customer order rates and we continue to be in a supply-constrained position. It will take several quarters before we can rebuild on-hand and channel inventories to our long-term target levels. Days receivable were 30 days, up 2 days sequentially, and days payable was 79 days, an increase of 4 days versus the prior quarter as we continue to increase material orders to our suppliers. Taken together, our cash conversion cycle was 32 days, up 1 day versus the prior quarter, reflecting strong customer demand, solid receivables collections, and positioning for customer deliveries in future periods. Cash flow from operations was $732 million, and net CapEx was $150 million, resulting in non-GAAP free cash flow of $582 million. Turning to our expectations for the second quarter. As Kurt mentioned, we anticipate Q2 revenue to be about $2.57 billion, plus or minus about $70 million. At the midpoint, this is up 41% year-on-year and flat sequentially. We expect non-GAAP gross profit to be about 55.5%, plus or minus 30 basis points. Operating expenses are expected to be about $623 million, plus or minus about $10 million. Taken together, we see non-GAAP operating margin to be about 31.3% to the midpoint. We estimate non-GAAP financial expense to be about $87 million and anticipate cash tax related to ongoing operations to be about $55 million. Non-controlling interest will be about $9 million, and for the second quarter, we suggest that for modeling purposes, you use an average share count of 283 million shares. Finally, I have a few closing comments. Firstly, demand trends continue to be strong across our target markets, and customer interest in our newest products continues to be robust. We are diligently working with our customers and our suppliers to address order requests in a timely manner. Our second quarter guidance reflects the clear potential of our business model, both in terms of revenue growth, and the significant fall-through, which will enable us to drive our non-GAAP gross margin target to the 55% level. With the new United States administration in place, the potential increase in corporate income taxes is a large topic of interest. Unfortunately, at this point in time, there are too many variables in play, making it impossible for any company to forecast. Therefore, it seems pointless to speculate until we have more clarity. On a more positive note, we do expect our cash taxes to be slightly lower than originally envisioned for 2021. So, 2021 will likely be 9% versus the previously indicated 10%. Fourthly, as we've said in the past, our capital return policy is to return all excess free cash flow to our owners. During the first quarter, the Board approved a $2 billion buyback authorization as well as a 50% increase in our quarterly cash dividend. During the quarter, we returned $1 billion to shareholders, and we will continue to execute our stated capital return policy. Fifthly, as Kurt mentioned, we believe the demand environment is strong. Notwithstanding the supply constraints, we believe the second half of 2021 will be greater than the first half of the year. Lastly, I'd like to thank all my colleagues at NXP for their dedication and the incredible job executing in a truly unbelievable environment. So with that, I'd like to turn it back to the operator for any questions you might have.

Renz, we'll poll for questions.

Yes, good morning, good afternoon. Thank you for taking the question. I guess, Kurt, I'm intrigued by your commentary around being in the early stages of a long-term growth cycle for NXP. I think we all understand the growth drivers behind the story but would love to hear what's changed in your view, say, in the last three months? And if you could walk through that, that would be great.

Yes, many thanks, C.J. Yes, absolutely. So, we do see ourselves just being at the beginning of a longer-term growth cycle. In that respect, I also tried to clarify that we do see the second half of the year growing again over the first half of this year. What has changed over the last three months is that the demand environment has, not only continued to be strong, but I would say we started to understand better and better some of the sustainable drivers of the demand environment. With us being 50% exposed to the automotive end market, this is clearly one place where we now understand how content increases are contributing significantly to this very robust demand environment where we see no reason why that should ease off. Our understanding of the demand environment has become better and deeper, and with that, we better believe in it. We are totally ruling out double ordering and any fears of piling inventories anywhere. In our key segments, especially automotive, industrial, and mobile, we know that what we ship out is immediately being built into products, and no inventory is being built anywhere.

Very helpful. If I could follow up, Peter. Obviously, reaching 55%-plus is a great achievement, but the next question is always what have you done for me lately? I'm curious if the model holds true going forward. Does every 5% increase in revenues yield a 100 basis points uptick in gross margins, or how should we be thinking about the trajectory from here?

No, I wasn't thinking of it that way. In 2019 and 2020, we were continually struggling on utilization. We were trying to use that kind of rule of thumb to explain what might happen as we approach full utilization. The good news now is, as we've always said, around about 2.4, we could run 55%. We're now internally at the high end of our utilization. I feel confident about the gross margin numbers where we are. We will probably do about 7% CapEx this year. We are adding capacity, particularly in the back ends to cope with the additional revenue we're seeing. Over the last year or two, we've seen the percentage of product we buy externally move from the low 50s to the high 50s. So, I'd say from a gross margin perspective, the challenge is to demonstrate that we can consistently run at 55%, which we feel very comfortable about. Over the next few years it will be the new product introductions and improving the cost performance of our products that will move us up to 57%.

Very helpful. Thank you.

Good morning, guys. Thanks for letting me ask the question, and congrats on the strong results. Peter, I want to dive into the gross margin a little more tactically in the near term. Can you just discuss what drove the upside in the first quarter and the second quarter, especially considering the mix between segments isn't really contributing significantly? So just a little bit of color on how you beat and then raised in the quarter and guide?

Yes. In the first quarter, the biggest move, Ross, was mix. We shipped proportionately less auto and more IoT. To be honest, $10 million gives you 40 or 50 basis points of margin, so we're not talking about huge numbers. As we go from Q1 to Q2, utilization will be key. We are not only able to run; obviously, not in Austin, but in our other fabs full out. We have really great utilization now in our back ends. There are always a few small things moving in different directions. But I think Q1 was about mix, which helped us beat guidance, while Q1 to Q2 is really about utilization and we're confident about our gross margin going forward.

Great. I guess my follow-up is for Kurt. You talked about confidence in the demand, specifically the lack of double ordering in the second half over the first half. If I narrow it down to your automotive business, historically, we've had a typical delta of content above SAAR. It sounds like you're confident that this delta is actually expanding. What's changed?

Yes, thanks, Ross. It's not all of a sudden surprising; we've seen it building over the last year. If you think about content increases, this is a comparison to 2019, a more normal year. Over that time, the content increase is not that crazy. There are two significant aspects: production rates of electric vehicles are increasing faster than anticipated, making it a content-rich story. We are now reaping the benefits of design wins in areas we've worked hard on in the past years. Our growth rates in focus businesses like radar, ADAS, and battery management are clearly pulling ahead the growth. There’s underlying momentum in content gains, but a part of it is also company-specific and reflects share gains for NXP.

Thank you.

Thanks for taking my question. I had two as well. First, on gross margin, Peter, I'm curious what role pricing plays, if any, in your gross margin. And if your Q3 and Q4 sales are above your Q2 sales, can gross margins also exceed 55% in each of those two quarters?

Regarding pricing, it is having no impact whatsoever, Vivek. We said on our last call that although some suppliers were tactical and trying to take advantage of the situation, that was not our strategy. We would definitely pass on any cost increases that we have, and we are able to do that. But we have no intention of trying to improve our profitability by gouging our customers. There’s certainly no impact like that in Q1 or Q2. As for the second half, gross margin isn't really driven by additional revenue. Yes, there could be some small impacts here. I have strong confidence in the gross margin level we're at the moment, and we need to focus on how we can bring out new products to improve profitability.

Got it. And my follow-up for Kurt, how much of the unfulfilled demand that you see this year can help extend the cycle into 2022? What can automotive customers do differently to extend your demand cycle and visibility?

That's a great question. On the automotive side, we are working diligently both with our customers, which are the Tier 1s, and directly with the car companies to prudently understand future demand patterns. One of the biggest learnings from the current situation is to build more transparency about the content increases that are often application and module-specific, mapping them out not just over the next two quarters but over the next eight to 16 quarters. This work is underway with all the top 10 car OEMs. We also work hard with our mainly wafer suppliers and back-end extensions to ramp up our supply capability quickly. I previously mentioned that in the second half of the year, we see positive revenue trends. Some of that demand is being satisfied already in the second half, a long-term story. But overall, trust that we are moving forward with a robust understanding of the demand environment.

Thank you.

Hi guys. Thanks for taking my questions. My first question is about the channel inventory situation. I know you said that you're confident that nothing you're shipping across your core markets is going on the shelf. How do you know that it's not going on the shelf in industrial and mobile?

It's really the direct customer exposure we have there. In mobile, the number of end customers isn't that big, and we know their needs for our product. In industrial, we have some large customers that are in very direct contact with us, and I have firsthand knowledge about their demand and build situation. It's based on very personal exposure that gives us confidence about product usage.

Got it. For my follow-up, you talked about the auto trajectory. You said it's up like 20% in the first half of '21 versus the first half of '19. Can you give us some view of how much of that 20% increase is content versus units?

That's hard to say. What I'm saying is indeed that we will have at least 20% growth over the first half of '19. If you think about the content, remember this is two years of content increase, as last year the car production was down significantly. But that doesn’t mean that content growth stopped. A realistic estimate for content increase might be around 10% per year. So, that gives you a 20% difference over two years.

Got it. So it sounds like the majority is from content; is that the right way to characterize it?

I would certainly say that because the car production itself is down by 10%. So it must be content and share gains.

Yes. Good morning guys. Thanks for letting me ask the question. Congratulations on the strong result. Kurt, my first question is just around getting a little more detail around the Austin shutdown and reopening. You talked last quarter about it being about a $100 million impact to Q2. Is that exactly what you saw? Were there any incremental costs that hit your model because of Austin, and do you expect to recoup them via business insurance as the year unfolds?

Yes. Let me address the revenue side first, John. The factory closures were unfortunate for both NXP and our customers. The closures hit on February 15. By mid-April, both facilities were running again at pre-storm levels. We had previously said we would expect a $100 million impact on revenues in Q2. We observe sequential flat guidance due to other means we found to make up for that loss. We’ll make up that $100 million in revenues in the second half of the year since our factories are fully operational. Regarding costs, we had minimal impacts from factory damage, and we have insurance to cover everything. The real impact was the deductible, leading to a modest effect on our model.

That's really helpful. Kurt, you compared the first half of this year to 2019 which shows an impressive growth rate, and I wonder how you view your long-term growth target of 5% to 7% versus the 12% growth you've seen since 2019?

That’s a good observation, John, but we will update our model with our next Capital Markets Day. We cannot and will not give a new long-term guidance at this time. The 5% to 7% is what we have. However, I agree that some content drivers are in good shape in automotive, and trends in mobile look robust. Let's not forget that 2018, 2019, and 2020 were not great years from a market perspective. So it's tempting to take just two good years as a reflection. We need to observe this from a longer-term perspective. Content drivers and company-specific drivers will matter moving forward.

Great. Thanks for taking my questions. Kurt or Peter, can you identify a product area where your ability to deliver lags the most versus demand? Is it concentrated in IoT and industrial, or are there specific products?

It's quite broad because it pertains to technology and capacity buckets, which affect multiple markets. It's not limited to automotive or specific distribution end markets. Automotive might garner more headlines because of its impact on complete cars, but large industrial applications also face shortages across the industry.

Thanks for that. Regarding the capacity additions, can you share if more comes on later this year? Is it incremental yields or any step functions in capacity?

Yes, there are three elements. First, catching up from the closed factories, which is about $100 million. Second, better wafer supply from external foundries, as they have been increasing allocations for fundamental capacity. Third, we are continuously increasing back-end capacity to cope with the additional revenue. These moves collectively will help increase Q3 and Q4 revenue levels.

Hey, thanks for taking my question. Kurt, just to clarify, the $100 million impact in March mainly hit the automotive channel, right?

Yes, the auto impact hit first due to supply chain dryness before the event occurred. Our comms infra business is also affected, leading to a guidance decrease for that segment in Q2. That impact will be temporary.

Regarding supply chain, when do you think the market will catch up?

I can't give a precise timeline. Supply is increasing, but I don't anticipate a full easing off this year. It will likely continue somewhat into next year. While supply is ramping up, demand stays strong.

Yes, thank you. Good morning. I want to clarify capacity additions. There's capacity coming online at foundries in the second half of this year. Should we expect more to come at the beginning of next year as well? Also, you previously stated that inventories would not be replenished until the end of the year. Does that mean by the end of the year, you think you will be fully meeting customer demand with the added capacity?

Yes, we are constantly working on increasing capacity. This effort will extend into next year, including commitments of over $1 billion to secure long-term supply with suppliers. We expect demand to be met in the second half of the year, and we do not anticipate this to ease off completely by the end of this year.

That was my last question. Would you like to provide some closing remarks, Kurt?

Yes. Thanks much, Jeff. Thank you all for being on the call today. I trust we could paint a clear perspective on how we see this continued and rapid rebound in demand across all of our end markets. We are glad that we brought our Austin factories back online and are now fully operational. We want to ensure you hear us loud and clear: second-half revenue will be above first-half revenue, and this is not just based on the $100 million catch-up from the closed factories. We are very confident that we can continue to drive consistent growth with improved profitability levels, thus enhancing our free cash flow. Thank you for your attention, and we'll speak again next time.

Thank you, everybody, for your interest, and that will be the end of the call today.