NXP Semiconductors NV (NXPI) — Q2 2021 Earnings Call Transcript

Thank you, Crystal, and good morning, everyone. Welcome to the NXP Semiconductor's second 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 can 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 specific end markets in which we operate, the sale of new and existing products and our expectations for the financial results for the third 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. Additionally, we will refer to certain non-GAAP financial measures, 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 Q2 earnings press release, which will be furnished to the SEC on Form 8-K and available on NXP's website in the Investor Relations section at nxp.com. Before we start the call today, I'd like to highlight our upcoming 2021 Analyst Day. At this time, we are planning on hosting an in-person event in New York City on Thursday, November 11, 2021. We will open up an online registration site over the next week, and we would suggest interested parties to pre-register as space will be limited this cycle. I would like to now turn the call over to Kurt.

Yes. Thank you very much, Jeff, and good morning, everyone. We really appreciate you joining our call today. I will review our quarter two results and I will discuss our guidance for quarter three. Furthermore, I will provide an updated perspective on how we view the current demand environment. Now let me start with quarter two. Overall, our results were better than the midpoint of our guidance with the contribution from the communication infrastructure end markets stronger than planned and above the high end of our guidance. At the same time, the trends in the auto, industrial and mobile markets were all slightly above the midpoint of our guidance. Taken together, NXP delivered quarter two revenue of $2.6 billion, an increase of 43% year-on-year and $26 million above the midpoint of our guidance range. These are very good results given the constrained supply position we knew we would face entering the quarter. Our non-GAAP operating margin in quarter two was a strong 32%, 1,130 basis points better than the year-ago period and 70 basis points above the midpoint of our guidance. Our strong operating profit performance was driven by a richer product mix. Now let me turn to the specific trends in our focused end markets. In automotive, quarter two revenue was $1.26 billion, up 87% versus the year-ago period and slightly above the midpoint of our guidance. In industrial and IoT, quarter two revenue was $571 million, up 31% versus the year-ago period and slightly above the midpoint of our guidance. In mobile, quarter two revenue was $347 million, up 36% versus the year-ago period and slightly above the midpoint of our guidance. And lastly, in communication infrastructure and other, quarter two revenue was $416 million, down 8% year-on-year, however, about $21 million better than our guidance. With this, let me move to our outlook. We are guiding the midpoint of quarter three revenue to $2.85 billion, up 26% versus the third quarter of 2020, within the range of up 22% to up 29% year-on-year. From a sequential perspective, this is up 10% at the midpoint versus the prior quarter. At the midpoint of this range, we anticipate the following trends in our business. Automotive is expected to be up in the low-50% range versus quarter three 2020 and up in the mid-teens range versus quarter two '21. Industrial and IoT is expected to be up in the high-teens percent range year-on-year and up in the mid-single-digit range versus quarter two '21. Mobile is expected to be down in the low-single-digit range year-on-year and down in the mid-single-digit range versus quarter two '21. And finally, communication infrastructure and other is expected to be up in the low-single-digit range versus the same period a year ago and up about 10% on a sequential basis. At this point, let me give you an update on NXP's current demand position. As I shared with you on our last earnings call, we had anticipated product supply to be a challenge in quarter two, and this is indeed what we experienced. With the continuation of robust demand, we expect supply to be a challenge for the foreseeable future. We do continue to work very closely with our customers on a day-to-day basis to accommodate their most pressing short-term requirements. During quarter two, based on the orders and all of the various actions we took over the last six to nine months, we began to see wafer supply from our foundry partners and internal fabs improve. We do anticipate continued increase of wafer supply during quarter three and beyond, which will support our revenue growth in subsequent quarters. However, with customer demand outstripping current supply, a situation that we see across all our end markets, we are working diligently to secure additional supply to achieve a healthy balance of demand versus supply. A significant number of our customers are also taking action by placing non-cancellable and non-returnable orders for the medium term. Furthermore, based on customer discussions and also based on our own analysis, we do not believe there is excess inventory of NXP components along the extended supply chain. Additionally, we continue to make significant investments as a direct result of the very detailed conversations and associated commitments concerning long-term demand across our customer base, especially within the automotive and industrial end markets. These investments include long-term contractual commitments to our front-end foundry partners in order to assure supply as well as making investments to expand our internal front-end capacity and our internal back-end test and assembly capabilities so as to avoid potential bottlenecks as wafer supply materializes. Notwithstanding this challenging supply environment, our results and guidance clearly validate the excellent underlying long-term growth, profitability, and cash-generating capability of our business. We continue to see our company-specific key revenue growth drivers in our strategic end markets unfold as we have long anticipated. These drivers include our 77 gigahertz radar systems, our e-corporate solutions, the domain and zonal processes, and the electrification products, including our battery management systems, all in the automotive market. And within the broad-based industrial and IoT market, our significant and focused investments to enable complete secure connected edge processing solutions are being very well validated by strong customer design win awards. And these are just a few of the opportunities we have shared with you at our Product Teach-In, all of them will continue to contribute to our future growth. While we will not provide specific guidance beyond the current quarter, we do anticipate quarter four revenue will be greater than quarter three on an absolute basis. And we are highly confident that 2021 marks just the beginning of a longer-term upside for NXP within our strategic end markets. In summary, we are very encouraged by the continued and consistent rapid rebound in demand across our end markets. Our employees are highly engaged to drive our success. We have a robust pipeline of new and innovative products. And the customer response engagement and design win momentum all underpin our optimism about the future potential of NXP. Before concluding my prepared remarks, I would like to speak to the impact the COVID-19 pandemic continues to have on NXP. The pandemic remains active with spikes that continue to plague multiple regions where we have operations, namely India in the second quarter and Southeast Asia most recently. We continued to remain very vigilant enforcing our safety protocols across all of our global sites. We have initiated successful vaccination drives in several countries for our team members and their families. However, the highly contagious Delta variant has required that we revert to a complete work-from-home situation in several of our locations. I am extremely proud of all our employees for their dedication and for their resilience during this very challenging period. I would like to especially commend our manufacturing operations and customer-facing teams for their relentless focus and energy while assuring our customer success. It is their dedication and their hard work in the face of the pandemic and the very challenging supply environment at the same time, which truly make a difference. Now I would like to pass the call over to you, Peter, for a review of our financial performance.

Thanks, Kurt. Good morning everyone. Since Kurt has already discussed the factors contributing to our revenue in the second quarter and shared our revenue outlook for the third quarter, I will focus on the financial highlights. Our performance in the second quarter was strong, with revenues exceeding the midpoint of our guidance. We also saw improvements in non-GAAP gross profit and non-GAAP operating profit, both surpassing the upper end of our guidance range. Furthermore, we have established long-term supply agreements with our foundry partners that we believe will help NXP achieve significant growth in the upcoming periods. In the second quarter, total revenue reached $2.6 billion, marking a 43% increase year-over-year and was above our guidance midpoint. We achieved $1.46 billion in non-GAAP gross profit, resulting in a non-GAAP gross margin of 56.1%, which is up 700 basis points year-over-year and above our expectations. Non-GAAP operating expenses totaled $626 million, rising by $110 million year-over-year and by $26 million compared to the second quarter. This amount was $3 million above our guidance midpoint due to increased variable compensation reflecting an improved performance in the first half. Our non-GAAP operating profit stood at $830 million, with a non-GAAP operating margin of 32%, which is up 1,130 basis points year-over-year and also above our guidance. Non-GAAP interest expense was $91 million, which exceeded guidance by $4 million because we issued $2 billion in new debt early in the quarter. Cash taxes for ongoing operations totaled $50 million, and non-controlling interest was $9 million, with below-the-line items performing $1 million better than guidance. Stock-based compensation, which we do not include in non-GAAP earnings, reached $93 million. Regarding changes in our cash and debt, total debt at the end of the second quarter amounted to $9.59 billion, which increased by $1.98 billion due to the debt issuance I mentioned. Our cash position was $2.91 billion, reflecting an increase of $1.07 billion sequentially due to new debt and cash generation, counterbalanced by capital returns during the quarter. Consequently, our net debt was $6.68 billion, with a trailing 12-month adjusted EBITDA of $3.55 billion. At the end of the second quarter, the ratio of net debt to trailing 12-month adjusted EBITDA was 1.9 times, and our adjusted EBITDA interest coverage was 10 times. We maintain excellent liquidity and a robust balance sheet. During the second quarter, we bought back $1.2 billion of our shares and paid out $155 million in cash dividends, totaling $1.36 billion returned to our shareholders. After the second quarter, between July 5 and August 2, we repurchased another $1 billion of shares through our 10b5-1 program, bringing our year-to-date total to $3.37 billion returned to shareholders. Looking at working capital metrics, days of inventory stood at 88 days, an increase of 7 days sequentially. Our DIO remains below our long-term target of 95 days, and the increase was driven by work in process due to wafer supply deliveries supporting our Q3 revenue ramp, while finished goods levels remained very low. We are effectively managing our distribution channel, with inventory in the channel at 1.6 months, steady sequentially and below our long-term targets. These metrics illustrate sustained strong customer order rates and a tight supply environment. It will take several quarters to rebuild our on-hand and channel inventories to reach our long-term target levels. Days receivables increased to 35 days, up 5 days, while days payable were at 92 days, a 13-day increase versus the previous quarter, as we ramp up material orders with our suppliers. As a result, our cash conversion cycle was 31 days, reflecting a 1-day improvement from the prior quarter, driven by strong customer demand, solid receivables collections, and preparations for future customer deliveries. Cash flow from operations was $636 million, with net CapEx at $150 million, leading to non-GAAP free cash flow of $486 million. For the third quarter, we expect revenue to be approximately $2.85 billion, plus or minus $75 million. This midpoint reflects a year-over-year increase of 26% and a sequential rise of 10%. We anticipate non-GAAP gross margin to be around 56.3%, plus or minus 30 basis points, and operating expenses to be about $665 million, plus or minus around $10 million, in line with our long-term model. This leads us to expect a non-GAAP operating margin of about 33% at the midpoint. We estimate the non-GAAP financial expense to be approximately $96 million and expect cash taxes related to ongoing operations to be around $90 million. During the second quarter, we indicated that we expected the full year's cash tax rate for 2021 to be close to 9%, with effects more pronounced in the second half. Non-controlling interest is projected to be about $9 million, and for Q3 modeling, we suggest using an average share count of 271 million shares, which is approximately 13 million shares fewer than in the same period last year due to our continued implementation of our capital return policy. In conclusion, I want to highlight a few points. First, we continue to see strong demand trends in our target markets, with robust customer interest in our latest products. We are working diligently with both customers and suppliers to meet order requests promptly. Secondly, our third quarter guidance reflects the strong potential of our business model, showcasing both revenue growth and significant profitability, enabling us to exceed our gross margin targets. Third, our business is generating substantial free cash flow. We are investing in our internal manufacturing capabilities and increasing CapEx to expand both back-end capacity and front-end output. We remain committed to our capital return policy and will return all excess free cash flow to shareholders as long as our leverage ratio stays at or below 2 times net debt to trailing 12-month adjusted EBITDA. As Kurt mentioned, we believe the demand environment is strong, and despite supply constraints, we expect solid growth through the remainder of 2021 and into 2022. Finally, I would like to express my gratitude to all my colleagues for their hard work and dedication. We must remember that we continue to uphold strict pandemic protocols. I will now turn the call back over to the operator for your questions.

Yes. Good morning. Thank you for taking the question. I guess, first question for you, Kurt. I was hoping you could speak more about the current state of the auto industry. I think there is a fear among some investors that the current auto run rate is closer to peak than trough and would love to hear your thoughts, what gives you confidence that strength is sustainable into '22 and beyond?

Yes, hi. Good morning, CJ. We are clearly convinced that we are far away from a peak, especially in the auto end market. The way to look at this is clearly that while the SAR this year probably is going to grow around 10%, that's the latest data point we have from IHS, there is broad consensus that it's going to grow another around 10% next year, and only then it will actually surpass the absolute volume levels from the pre-pandemic year of 2019. But more importantly, CJ, as we've discussed many times in the past, our content gains, company-specific content gains, and I mentioned a few in my prepared remarks, like radar, eCockpit, zonal processes and the battery management in electrification, really, really drives specific strength and growth for NXP. And from a market perspective, I'd say that the content gains in general maybe are accelerating a little, especially thanks to the accelerated pace to xEVs. So we do see that the number of xEVs as a portion of the total car production is growing faster than anybody had anticipated. The latest data we see, again, I'm quoting I think IHS here, it was like 12% of the total car production last year dedicated for xEVs. It's going to be more like a quarter next year and then growing fast from there further onwards. Since xEVs have a significantly higher silicon content compared to traditional combustion engine vehicles, this is another strong driver for the auto market. So far away from a peak. And finally, very tactically, because I know everybody wants to speak and wants to hear about that. I mean, trust me, I'm in daily contact with the CEOs of the both the Tier 1 customers of us, which are serving the car companies and the car companies themselves, on a daily level trying to make sure that we can fulfill their most pressing needs, really handholding shipments day in day out. So there is not a single piece of inventory anywhere in the extended supply chain. They want to build more cars. So I have any confidence that this keeps growing.

That's very helpful. Thank you. I guess, as a follow-up, Peter, gross margins are stellar. I think reading your 10-Q, you talked about the benefit of increased loadings, but that mix was not helpful and that you had higher personnel costs. How are you thinking about I guess COVID-related costs unwinding? What kind of impact that would have on a positive side? And from current levels, how should we be thinking about uplift from here as presumably loadings continue to move higher?

I believe that, regarding the COVID test and its effect on our gross margin, the costs are relatively low. We've maintained our factory operations much as we did previously, although there is the added expense of more frequent disinfection and medical support. However, I don't believe these costs are substantial enough to significantly impact the margin. As for the increased utilization, we are already starting to see benefits as we transition from Q2 to Q3. Our guidance of 56.3% for Q3 reflects our gross margin with our factories operating at full capacity. Looking ahead to 2022, you won't see increased utilization since we need to add more capacity; we're pretty much running at full capacity in Q3. I still consider 56% a strong figure for us, and we've reached it faster than anticipated. However, achieving 57% is still a couple of years away and will primarily depend on the introduction of new products. The mix positively influenced our performance from Q1 to Q2, which is why we improved in Q2. The main factor driving the change from Q2 to Q3 will be the additional utilization and the ability to fully operate our backend facilities.

Very helpful. Thank you.

Thank you for taking my questions. On the first one, Kurt, specific to autos, when do you think supply increases enough to meet demand? And importantly, what should investors look to be reassured that the industry supply response will be disciplined? So for example, if we see headlines around any specific foundry increasing microcontroller production significantly, how should we react to that? So I appreciate that you mentioned that you are in daily touch with customers and there isn't any inventory today, but as you also mentioned, the industry is increasing supply. So how should we be assured that the supply response is not going to overwhelm demand at some point?

Yes, good morning, Vivek. We are monitoring this situation very closely as always. I want to reassure you that we believe we are still quite a distance from that scenario. Currently, the industry is still experiencing a supply shortage. Regarding the statements you've mentioned about a 60% increase in microcontroller shipments, that's not entirely accurate. Our auto supply revenue for the first and second quarters combined is about 50% higher than last year, which reflects the industry's performance, especially considering the record lows last year provides a less reliable benchmark. It's more appropriate to compare our current situation to 2019 or even 2018 when car production levels were at their peak. To assess this, most of our products are application-specific, and we maintain close contact not just with Tier 1 suppliers but also directly with the OEMs. This has given us exceptional visibility into true demand, more than we have ever had before. Regarding distribution, we remain very disciplined with our inventory, having maintained a low number of 1.6 months. Although that's a change from the previous quarter, our target is around 2.4 to 2.5 months. We're keeping a close watch on this, especially given the supply situation. The increase in transparency has been significant, particularly for the application-specific products we handle. I can see how your concerns may apply to more commodity-like products, but in our case, there is clarity regarding which products go into which applications for which car companies. Therefore, I have much less concern regarding supply overwhelming demand, and I'm confident we are still quite far from the situation you're worried about.

Got it. Very helpful. And then for my follow-up, I'm curious why your mobile sales, if I heard correctly, would be down sequentially and then also year-on-year, because isn't Q3 supposed to be a seasonally stronger quarter for shipments into that market? And are we to assume that mobile sales will stay subdued even into Q4? So just why are mobile sales not behaving kind of in line with the usual seasonal pattern we see in that industry? Thank you.

Yes. Vivek, I'd say, in general, there isn't much of a seasonal pattern this year anyway given the situation. But here specifically, yes, you're right, we are guiding sequentially and also annually a little bit down. It really has to do with the supply constraints. So we have a supply constraint for some products in the mobile market, which we know we will address later on, so this is just of a temporary nature. But for quarter three, it just hits us that we can ship to the amount which we want to ship. The good news is, it doesn't cost us any market share, so we don't lose any socket with this. We fully keep our momentum going, and it's of a temporary nature. If you do the annual comparison, I also might want to remind you that last year Q3 was a bit of a special quarter in mobile because it was the last quarter before the Huawei ban, which actually benefited quarter three in our mobile business since people had a bit more in Q3 than since it stopped totally in quarter four. So that's the simple background not more.

Hi, guys. Thanks for taking my questions. For my first question, I wanted to double-click once again on the content increase in auto. I mean, you've called out EVs specifically. I guess, a couple of things. Can you tell us how much of your auto business is being driven by EV today? I guess, of those content-specific drivers, which one do you think is the biggest driver in the near term? And how much of the lift in the next quarter do you think is being driven just by end market unit growth versus like content increase because you're selling into higher content vehicles?

Yes. Stacy, in general, our key driver for revenue growth in xEVs is clearly the battery management solutions which have a fantastic exposure. I think in our Investor Teach-In, we told you that we would have 60% CAGR over the next couple of years. And I can absolutely reconfirm here that we are, at least, if not more than on track with that trend in battery management solutions. Now if you take it a little bit wider, it is actually more because a lot of our microcontrollers and other products are also very strongly exposed to the increased content of xEVs. We will actually go in a bit more detail on that particular question, Stacy, in our Investor Day, which Jeff has just highlighted, November 11 to parse it a little bit more in a more detailed way on how this shows up. But overall, just take it for granted that the double silicon content of a xEV versus the conventional drivetrain gives a significant benefit also to NXP. So we are significantly benefiting from a higher rate of xEVs, which is a strong push for our content growth story here.

Thank you. For my follow-up, I want to ask about the cash returns. You've bought back a significant amount of stock, with an authorization of $2.6 billion as of March, and you've utilized about $2.2 billion so far. You're approaching the end of this buyback program, yet you're still projecting a decrease in share counts. Should we anticipate even more returns? Will you exceed 100% return this year? Given the robust nature of the buyback, can you elaborate on what this indicates? It seems to underscore your confidence in growth for the upcoming year. Moreover, why are you buying back so much stock now, and should we expect additional cash returns as we progress through the year since it appears you're close to completing the buyback?

So maybe I'll take that. I guess the answer to your second or third question is that we have a lot of confidence in where the company is headed. Clearly, we believe that buying our stock right now is a sound investment. As for how much, it's quite straightforward. We've consistently stated that we will maintain our net debt to trailing 12 months EBITDA at a level of 2 times. We will continue to buy back to that level as needed for the foreseeable future. If that leads to us returning more than 100% this year, then that is the outcome. But honestly, it’s pretty mathematical; we’re just sticking to our plan of 2 times net debt.

Hi, thanks for giving me the opportunity to ask a question. I have one clarification and one question, plus a follow-up if that's okay. Have you shipped the $90 million in shortages from Texas? Have you resolved that in the automotive sector, or what's the status? That's my clarification. The longer-term question, perhaps for Kurt regarding the auto side, is whether you’re noticing any changes in customer behavior. The just-in-time practices in that sector seem to be facing challenges due to the recent demand surge. Are your discussions indicating any structural changes, or do you believe this is just a temporary reactive adjustment with no significant changes expected in the next couple of years for the industry regarding just-in-time?

Yes, thank you, Ross. Regarding the $100 million loss in second quarter revenue due to the winter storm affecting our two Texas facilities, that is accurate. I can confirm that both factories are fully operational again, and we have returned to pre-storm output levels and even improved upon them. This is encouraging news for our future revenue, as the output is steady and not just a one-time occurrence. It's also promising from a supply standpoint, particularly since both facilities serve the automotive and communications infrastructure markets that have been eagerly awaiting these products. We appreciate our employees for their efforts in quickly restoring operations. In response to your question, I am observing signs of a structural shift in the behavior of automotive customers. There are two main aspects to this. First, there's the realization that a just-in-time system doesn't mesh well with the three to six months manufacturing cycle typical in semiconductors unless there is some buffer in place. I believe we will see increased inventory along the extended supply chain as a result. While people are planning for this change, they are currently unable to implement it due to supply constraints. However, I anticipate this will eventually lead to a structural change. Secondly, we are experiencing unprecedented transparency from car manufacturers regarding product volumes and applications for specific model years. This collaboration is much stronger than before, which will lead to more binding forecasts. Such forecasts will enable us to better anticipate and plan for our capacity needs moving forward, representing a significant shift from past practices.

Thanks for that color, Kurt. One quickly for you, Peter. You gave great color on the gross margin side of things. Another target you guys have given historically is the OpEx intensity, and I think it ranges anywhere between 20% to 24% as of your last Analyst Meeting, and I know you might be updating that later this year. But can you talk just a little bit about the leverage potential there? I think this year it looks like you're running kind of within that target range, but at the higher end kind of 23%, 23.5%. Do you foresee some leverage getting to the lower end of that range or just generally how should we think of OpEx relative to revenue growth?

Certainly for the moment, I'd think of 23% of revenue, 16% for R&D and 7% for SG&A. There's probably some leverage in the SG&A number because although we typically increased sales and marketing, G&A, we'd more likely to hold flattened dollars. But I think certainly for the moment, 23% is a good number to plan on.

Yes. Good morning, guys. Thanks for letting me ask the question. Congratulations on the solid results. Kurt, I wanted to ask a little bit about your comm infrastructure business which came in much better than guide for the June quarter and it's going to grow nicely in the September quarter. I know that pre the Huawei ban, you were very excited by some design wins you've had won there, but clearly had to kind of temper expectations with the ban, but it seems like you guys might be more levered to the 5G cycle than some of us think. Can you just walk through kind of what you think is driving that growth, especially given how good the margin could be in that business?

Yes, John, we did discuss last year about making significant progress with a major Chinese customer, but that partnership did not materialize. I want to clarify that the business currently performing well and what we anticipate for the next quarter is not linked to that previous design win. The strong performance in the second quarter spans across various segments, including some contributions from 5G build-outs, but it's actually seen across all product sub-segments in this revenue category. So while 5G is part of it, it's not the only aspect. Regarding our positive guidance for the third quarter in communications infrastructure, we do observe two trends in 5G that are driving our growth. First, we expect increases in demand for our multi-technology modules in the U.S., which combines LDMOS and gallium nitride technology from our new facility in Arizona. Second, we are also effectively participating in China’s tenders for macro base stations in rural areas, operating in the frequency range below 2.1 gigahertz, which aligns perfectly with our LDMOS capabilities. These two factors—U.S. multi-technology modules for 5G and the CP3 tenders in China—are key drivers for our growth moving into Q3 and beyond.

That's really good color, Kurt. And then, Peter, in your prepared comments you talked about the high-class problem of needing to expect both front-end and back-end capacity. Is that mostly being done with outsourced partners, so it's more of a working capital hit than a CapEx hit or how do we think about CapEx over the next several quarters as you continue to try to make supply catch up to demand?

Capital expenditures will be around 7% this year, with an increase expected in the third and fourth quarters due to a lot of assembly and testing work, as well as addressing some bottlenecks in our manufacturing facilities. While capital expenditures will rise, I don't anticipate working capital increasing significantly. We would certainly prefer more inventory if feasible, but as quickly as we receive it, we tend to build it, which is reflected in our finished goods being at an all-time low. We do have slightly more raw materials and work in progress from foundries' shipments received toward the end of the quarter. Overall, we are definitely investing more in internal capacity, which will positively affect us next year, and we continue to collaborate closely with our other suppliers to secure additional supply. However, as promptly as we receive supplies, we build and ship them to our customers, so I don’t expect our inventory levels to return to anything resembling normal any time soon.

Great. Thanks for taking my questions, and I'll add my congratulations, especially on the guide, very strong. I'm wondering if you can remind us as sort of a clarification, the breakout within the comm infrastructure business. I think we tend to think about this as largely or all RF power amplifiers, but I know there is digital networking and I think there's still some ID card business in there as well. Can you remind us of the split and maybe how you expect the three of those pieces to grow over time?

So hi, Will. Thanks for your congrats on the guidance. The subset is indeed as you said, the RF power for infrastructure, it is about digital networking and there is some secure card business also in there. We will not break out the details between them, Will. But what I can say, and I think I mentioned it earlier, the outperformance in the second quarter was across all of them. So it wasn't limited to one of these sub-segments, but it was actually across all of them. When you think about the guide and the growth into the third quarter, it is probably less by the 5G-related comms infra RF power.

Thanks for that. And one more if I can there, sort of product question. I forget when, one or two years ago, perhaps, you started talking about the ultra wideband products and the growth that you anticipated seeing in handsets and automotive. And I'm wondering if you can provide some update in terms of your revenue traction in those two end markets for this product category and the outlooks for them today? Thank you.

Yes, I'm happy to provide an update, Will. Just to remind everyone, this is about a complete ecosystem, not just the product itself. We offer radio, secure elements, and software solutions across automotive, mobile, and IoT. We are on track to achieve revenue of approximately $300 million to $400 million in these segments by 2023. Currently, progress in the mobile sector is underway, particularly within the Android ecosystem, where we're collaborating closely with all major manufacturers. The automotive sector is following suit; this connection relies on the mobile use case, specifically the integration of mobile devices as car keys. The first vehicles incorporating this technology will be available in the second half of this year and into next year. I feel confident that any automotive company developing an ultra-wideband solution is partnering with NXP, which positions us favorably. Additionally, we're seeing positive momentum with initial IoT applications, like devices that help locate misplaced items, as well as design successes in smart door locks for homes, where mobile phones serve to unlock doors. We remain on track, aiming for the $300 million to $400 million revenue target in two years, as we anticipate the market growing by about 40% over the next few years.

Hi, good morning. Thank you for taking my question. I have one for Kurt or Peter. Could you provide more details on the long-term supply agreements you've already established with foundry partners or those you plan to sign in the future? We have seen reports about price increases from the foundries ahead. How should we consider the trade-off between cost inflation for your company and your capability to raise prices in the future? I assume the 57% figure you mentioned, Peter, reflects some of these factors, but I would appreciate clarification on that. Thank you.

I'll let Peter respond, but I want to emphasize an important point. Input costs are rising, and we do pass on these cost increases. However, this is not a strategy for us to artificially inflate margins. We have established long-term, trust-based relationships with our customers. While we do pass on input cost increases, this approach is not primarily aimed at structurally increasing margins. Peter, feel free to provide additional details.

I think you answered the question well, Kurt. We are not a commodity company; we don't increase prices when the market is tight and lower them when the market is stable. What's really interesting about this shift are two major factors. First, as Kurt mentioned earlier, it's allowing us to forge deeper connections with our customers and to better understand their needs and supply chains. Regarding our suppliers, without going into too much detail, we can identify our true partners who will support us in the long term and distinguish them from those who may be more opportunistic. Our market and supply chain rely on long-term relationships and stable sources of supply for both our customers and ourselves, leading to consistent pricing and profitability.

Thank you, and congrats.

Thank you, good morning. I have a question regarding the capacity additions and the increased capital expenditures you mentioned for the second half of the year. How long do you anticipate this trend will last? I assume that equipment lead times are also prolonged, so you must be providing your suppliers with some foresight on this. Essentially, how long do you expect to continue adding capacity to meet the current demand levels?

We will continue to require capacity for the foreseeable future because we believe our product cycle is strong. Over the past six months, people outside the semiconductor industry have started to realize that semiconductors are essential to everything we do. As GDP grows in the coming years, semiconductors are expected to grow at an even faster pace. Approximately 70% to 80% of our assembly and test capacity is internal, which will provide a consistent source of capital requirements. About 57% to 58% of our wafer supply comes from external sources. While we are not likely to build a new fab, we are continually upgrading our existing equipment to keep it current. Historically, we have allocated 5% to 7% of our budget for capital expenditures, and while last year was below 5%, this year we expect it to be at 7%. We will likely provide a longer-term outlook during our Analyst Day in November.

Capacity is internal, which will remain a healthy source of capital requirements. Approximately 57% to 58% of our wafer supply comes from external sources. We are not likely to construct a new fab, but we consistently upgrade the existing equipment to keep it current. Historically, we have communicated that we will allocate 5% to 7% for CapEx throughout the cycle. Last year, our spending was below 5%, and this year, it will be at 7%. We will likely provide a more long-term perspective at the Analyst Day in November.

I'm sorry, you're breaking up.

Thank you for fitting me in. I wanted to revisit the supply side and the timing of your deliveries. With the growth you've seen in September, will you need to ship out inventories, or can you match that growth with your supply? I'm trying to understand the timing of your deliveries. Also, regarding mobile, you mentioned that you're reprioritizing for a quarter. Is that a one-time adjustment, or are there other segments that you're needing to prioritize away from, even with the strong guidance in September?

Well, Blayne, we continue to be constrained across the board. And of course, we need to take all the time certain priority decisions, and indeed, mobile is kind of suffering in the third quarter, but everything is relatively sought across the board. The additional supply coming online is really gradual from many different sources. I mean, we talked about it. We have increasing traction with the mid and longer-term contracts with our foundry suppliers. We have Texas fully up and running by now. We have, as Peter alluded to, invested both into our internal testing, not only capability, but also looking at some expansions of our internal front-end factories. So all of these things across the different technologies and products are happening gradually. So it's not a one-time event. But I would say with the demand being as strong as we continue to foresee it, it will remain tight for a while. But the one really suffering in Q3 is indeed mobile.

Thanks. I want to ask about the auto side. The new model year typically brings a heavy March seasonality. It seems like you might be seeing the '22 model year coming earlier. I'm curious about your thoughts on the content aspect. You're benefiting from a shift to electric vehicles, but is auto seasonality different this year? Are you observing earlier model years? Please walk us through your thoughts on the seasonality for the auto business as we move past September.

Well, Blayne, I think I said for the total business that we expect Q4 in absolute revenue terms to be above Q3. That's one. Secondly, I don't think there is really seasonality in auto at this point in time because dealer inventories are at record lows in the U.S. and in China, and they just can't build as many cars as they would wish to build. So I think it's more a function of supply availability in terms of when they would do what. So at this point in time, it is really supply constrained for them, which I think overwrites any seasonality. At this point, Jeff, I guess we are running against time, right?

Yes, that's correct, Kurt.

Yes. So let me then maybe from my end conclude the call with saying, I hope we could give you a good view and transparency into the continued very strong demand which we are seeing across the board. And at the same time, the news that we are seeing increased supply capability coming online, which drives the strong guidance into the third quarter from a revenue perspective. We also told you that quarter four is going to be yet higher than quarter three, and we continue to see this trend going into the next year. And at the same time, we see that our gross margins are now very much hitting the mark, which we had anticipated for a long time. With that, I thank you for your attendance today. Thank you.