NXP Semiconductors N.V. (NASDAQ:NXPI) KBCM 2024 Technology Leadership Forum August 6, 2024 11:00 AM ET

Company Participants

Jeff Palmer - SVP, IR

Conference Call Participants

John Vinh - KeyBanc Capital Markets

John Vinh

Great. Good morning, everybody. My name is John Vinh. I cover semis here at KeyBanc Capital Markets, and we're pleased to have NXP with us. We have Jeff Palmer, Vice President of Investor Relations. Welcome, Jeff.

Jeff Palmer

Thanks, John. Nice to see you. Great to be here again.

John Vinh

Good to see you. Hey, so top of mind for everyone, Jeff, is, I'm sure you're having your conversation with investors is obviously the cycle. If you think about cycle, looks like you guys have done a better job of just managing through the volatility in the cycle than many of your peers. And you could argue that the automotive supply chain is much more complex than some of the other verticals. Maybe if you could just spend a few minutes discussing how you've managed to do this.

Jeff Palmer

Sure, John. Yes, I agree with you. It is topical. I think you have to kind of go back in time a little bit. And late in 2022, Q3 of 2022 actually is when we kind to realize this felt like the cyclical peak for our business. We started to see some kind of more weakening signals in the consumer side of the business and mobile and consumer IoT. And so, at that point in time, we made the decision to limit how much inventory was in our channel, distribution channels. As you know, about half of our revenue goes through global distribution. Our normal target of inventory in the channel is two and a half months. And with the supply crunch, we had gotten down to about 1.5 months. And so, as we kind of felt we were at the cyclical peak, we said, look, let's keep the channel lean and tight, and we decided to keep it at about 1.6 months, of which we've done since Q3 of 2022. That's on the distribution side, right?

On the direct side of the business, which is predominantly the auto, so automotive is 60% direct and 40% through the channel. On the direct side of things, last year in probably late spring, early summer, as you know, we had non-cancelable, non-returnable order programs. We started getting kind of the message from our direct automotive customers that said, hey, we know we have a contractual obligation with you to accept material. We signed up for it, but if you ship it to us, we're just going to put it on the shelf. So, we made the decision at that time to limit what we would force our customers to take. Now, we didn't do it just because we're nice guys. The first thing we said to them is, okay, how much inventory do you have and where do you want to get to? So, kind of, that was the stake in the ground that we wanted to have a conversation around. And secondarily we said, okay, we can't just let you off the hook for a business or arrangement because that's kind of foolish. So, we said, hey, give us design awards that maybe we were competing for. Let's talk about different price profiles, things like that. But basically what we did is we said, there's no benefit in jamming our direct customers. And so, at that point, if you think about it, spring of 2023, we are limiting the channel, what we were shipping in, and we decided to limit what we would force our direct customers to take. Now, some people might say, okay, that was foolish. You left dollars on the table, but our view is there's no benefit. It doesn't create demand to shove inventory into your customers. And that's really, I think how you can profile how we navigated the last couple of years on the cycle.

John Vinh

Got it. Maybe just to follow up there, I think Kurt made the comment on the call that, hey, you are finding business accommodations to help them work down that inventory you had referenced, maybe agreeing to awarding some design wins. Is that what you're primarily referring to, or are there other business accommodations that you've been able to construct with your customers in terms of helping them manage this?

Jeff Palmer

They tend to be around things like future business awards, pricing, because if you're letting somebody off the hook on a volume commitment, that means they're taking less than they've committed previously. And so, ASPs are a variable. It was more that type of a thing.

John Vinh

Okay, that makes sense. But number one question I have gotten from investors after your earnings call was, who's that customer that wants to only hold two weeks of inventory? I know you're not going to tell me who it is, but I was wondering if you could just talk about how your customers are thinking about what the new norm is in terms of inventories in this post-pandemic environment. Is it that they want to hold less or more than what they were holding pre-pandemic?

Jeff Palmer

Yes, I think what's important to understand is that 60% of our automotive customers that's direct. These are global tier ones. They tend to be primarily western European, North American tier ones. There's not a one size fits all. Each one has its own business conditions they want to try to achieve. We have some who want to hold inventory in the 10-to-12-week range, and we have one or two who think holding two weeks of inventory is the right idea. You're right, I'm not going to tell you who that tier one who wants to hold two weeks is, but I will say it is a very large European tier one. We will leave it at that.

John Vinh

So, does it feel like the pendulum's just shifted in their overreacting too much to wanting to hold too little inventory on average, if you were just to take a average or a sample across all your tier one customers at this point?

Jeff Palmer

Some of them are actually being pragmatic and are saying, look, 10 to 12 weeks makes sense because NXP, your cycle time is about that. So, that kind of makes sense. The ones who want to carry much less than that, their view is, look, Mr. NXP, intellectually, we know it's too lean, but we are under very tight financial conditions here. Our working capital metrics are not great. And so, while we know strategically this might not be the smartest idea long-term, tactically that's where we want to land. And so, it varies tier one to tier one.

John Vinh

Approximately how much was that customer holding pre-pandemic?

Jeff Palmer

It's a fair question, John, but we're not going drill into that. We do have - I mean, I reviewed your questions before we came in today. We do have some tier ones who want to revert to their battle pre-pandemic ways. Others are becoming a little bit more pragmatic. What's interesting this time around is the OEMs where the actual customers of the tier ones are getting a little bit more concerned about it because their view is if nothing changes, we're probably going to go into another supply crunch in 2025 or 2026. And so, we have started to see OEMs either put pressure on the tier ones where they can. Surprisingly, they don't have as much lever as we would've thought. And two, some of them, some large ones coming to us directly and saying, look, we can't force the tier ones to take this material, but we know it's the wrong thing what they're doing. We understand why they're doing it. So, Mr. NXP, we'd like to place direct orders with you. We'll take delivery of that product and then we'll fork it off to different tier ones. Now, it's not huge amounts of orders from these OEMs, but it's a change in trend and a change in behavior, and which is a positive coming out of the supply crunch in the last couple of years.

John Vinh

We had heard similar commentary from one of your other auto semi peers yesterday in terms of the, maybe this tension that's kind of building up between OEMs and tier ones. I'm surprised to hear you say that they don't have as much leverage as you would've thought. Why do you think that is? Because ultimately, they're the ones that are making all the design decisions for the tier ones, right?

Jeff Palmer

Right. I think you have to step back and look at it over a very long period of time, and the OEMs have not been easy customers to the tier ones, and they've put some onerous Ts and Cs on them, and they require top shelf service. And it's - and a lot of times what gives is the working capital, right? If you hold too much inventory, your free cash flow goes to heck. So, what I've heard is that a number of OEMs have said, look, we can't change the running business, but we can change the terms of conditions of new awards. And so, they see that they can modify behavior on future designs, which is good, and we also see some of those similar OEMs coming to us directly. So, what we're seeing is a change from the old days.

John Vinh

Yes. So, that's another interesting point that you're bringing up, Jeff, is it sounds like your relationship coming out of the pandemic is getting stronger with the OEMs, that you're going more directly to them versus previously maybe sometimes you'll be going through some of the tier ones. Is that fair to say?

Jeff Palmer

Yes. So, historically, all of our business transacted with tier ones. So, that's our normal process. For a number of years, we've been working with the OEMs on design awards, but I would say it's more at the engineering R&D to R&D level. Through the supply crunch, there was a much-heightened executive to executive type of relationship between Kurt and Bill, our CEO and CFO and the OEMs of different automotive companies. That's been helpful from a supply chain perspective, but it's also been much more impactful from some of the new design wins we're doing in the area of software-defined vehicle. I know we'll talk about that in a little bit, but a lot of the newer next-generation platforms are really being awarded by the OEMs directly, not through the tier ones like it normally used to be.

John Vinh

And going direct to the OEMs, has that helped also in negotiating kind of pricing on some of these new words at all or?

Jeff Palmer

At the end of the day, the tier ones are still there converting chips into cars. And so, no, it doesn't - there's not what I would call a huge benefit. What does occur is we have better insights into the architecture of platforms. We understand the strategy of the OEMs, where they're looking to position these platforms. It gives us more of an insight, where in the tier one world, you basically only saw your part of the overall system.

John Vinh

Great. Maybe going back to channel inventories, a quarter ago you had started to message that to kind of complete this soft landing scenario, you were going to start filling up the channel again, and then you kind of came up with the most recent earnings call and said, hey, we're going to hold off here. What's the reason why you decided to kind of hold off here?

Jeff Palmer

Yes, two reasons, actually three, two of them external, one internal. So, the two external reasons is one, in the automotive tier ones, we were talking about how much inventory they have and how we've been trying to help them burn that off. We had a certain view of how that inventory would burn off from a time perspective and where the landing point would be. That had shifted over the last 90 days. So, the burn-off rate slowed a bit, and the landing point of where they wanted to end up went down even further in aggregate. And so, we said, okay, we need to be a little bit more cautious here. Secondarily, in our industrial and IoT business, which is about 20% of the total company, we saw weak demands in the core industrial side in North America and Europe. And since industrial and IoT is about 80% through the channel, we saw no reason to continue to refill the channels significantly. So, it's really just a pushing off of the timeline of when we will refill the channel. We do at some point want to get back to our two and a half months. It won't be here this year in 2024. Sometime in 2025, all else being equal, seems reasonable at this point.

John Vinh

And is there a way to think about, what do you need to see to kind of - to make that decision to start refilling the channel? Are there certain metrics and inventory levels that you're watching for to get comfortable?

Jeff Palmer

Yes. So, over the last probably five or six years, we’ve built a pretty automated system to monitor the distribution channel on a global basis. We can see what we sell in on a daily basis, what gets sold out, how much inventory, part number, what geographies it ends. And so, I'd say we have a very good handle on what happens in the channel. And so, what we're going to want to see is a higher velocity of sellout of the channel, right? As we see that go up and on-hand inventories in the channel go down, that's a signal to us, okay, let's start to refill in a more measured way. In either way, just as we measured the cycle down through the channel, we're going to be very measured and conservative, if you will, on the up cycle as well.

John Vinh

Great. Questions?

Question-and-Answer Session

Q - Unidentified Analyst

Can you just quantify your (indiscernible) of 1.7 indiscernible). How do we think about that on your revenue?

Jeff Palmer

Sure. Yes. So, the question is, can I kind of give you a metric of what the value is of going from 1.7 months of inventory in the channel to two and a half? So, kind of the rule of thumb is for every 0.1 month of inventory, it's about $50 million. So, I think when we were running it at about 1.5, 1.6 months, we used the aggregate target of about $500 million to refill. Now, since that time, we've gone from 1.5 to 1.7. I'll let you do the chance on math on that.

John Vinh

Good. Any other questions? Great. Hey Jeff, I think you also referenced kind of some company-specific drivers that that should help things kind of recover few in the second half. I think radar was one of them. I think you talked about ramping some new radar wins. I'm just wondering, are these the new 28-nanometer RF CMOS solutions? Can you talk about what the advantages of these solutions are and how do we think about content or the market share impact view?

Jeff Palmer

Yes. So, radar for us is a very key part of our automotive business. We said that our radar business would grow from about $600 million in 2021 to about $1 billion, $1.1 billion in 2024. I'd say that trajectory is still correct directionally. We don't have just a single part. We have a whole portfolio of different radar products we sell. The 28-nanometer of RFCMOS is a one chip integrated 77 gigahertz radar product. What's the benefit of going to 28-nanometer CMOS? You can integrate the processor and the transceiver front end into the same dye. And so, you get a lower power, smaller dye, good cost effectiveness, which enables the auto OEM to distribute those devices in multiple areas around the car. So, that's one type of radar node we sell. We still continue to sell silicon germanium front-facing radar, which tends to still be very good technology for distance, but that tends to be a two-chip or multi-chip solution because there's no integration path with silicon germanium. So, just the point to make, John, is that it's not a single part portfolio. There's multiple parts. There is some 28-nanometer in the design awards, but some of it is some of the other products as well.

John Vinh

Got it.

Jeff Palmer

And you have to also remember, for automotive design awards, it's a two-to-three-year design to revenue cycle. So, when we get close to when a product starts to ramp is when our interaction with the OEM who awarded us design goes up, but we've been babysitting these designs for some time. They didn't just pop up last quarter.

John Vinh

Okay. Are these kind of multiple designs that are going in production or is this kind of a big platform win?

Jeff Palmer

It's multiple. So, there's a smaller number of tier ones globally that actually are in the radar business, if you will, primarily in North America and in Europe. And it's just more expanding that footprint with those OEMs, tier ones.

John Vinh

Maybe we can also talk about software-defined vehicle. This sounds like a big opportunity for you. When we start seeing cars roll in production with this new architecture, can you talk about what the incremental content opportunity for you is? And when you think about SDV, is this more of a TAM expansion opportunity, or are there NXP-specific advantages that's going to allow you to benefit more from this than others?

Jeff Palmer

Okay. It's a lot there. So, one, I do think it is a TAM expansion, but I do think that we, as one of the early movers in this area, will have a disproportionate advantage from that TAM expansion. The first time you'll be able to probably buy a car that will have a five-nanometer vehicle computer from NXP will probably be the model year 2026 or 2027. So, late next year is when model 2026 will start to go into production. We're already shipping domain and zonal processors into early - kind of what I would call early versions of SDV. Our S32 family, which is the processor family that's behind software-defined vehicles, we started shipping revenue materially in 2021. It was about $300 million of revenue in 2021. We expect it to hit at least $600 million this year. And I'm pleased to say we're ahead of that target. So, the adoption rate's been very good, but that's been primarily on our domain and zonal products, so the 16-nanometer domain products and the 28- and 40-nanometer zonal products. The thing about the software-defined vehicle evolution is you're not going to go into a car dealership and they're going to say, here's a software-defined vehicle. What this is, is really the infrastructure of the car. It's the part of the car you as a consumer really don't see and touch and feel day to day. But think of it this way, if we were all to go buy a car today, the best year of that car is the day we drive it off the lot today. It's kind of a - it stretched a ways from a functionality perspective. The whole idea of the software-defined vehicle is as you - once you drive that car off the lot, over time, the OEM can update through over the air updates the software of different functions in the car that will keep that car feeling fresh and bring maybe new features to you. So, the idea is when you actually drive that the next-generation car off the lot, it will have quite a bit of processing headroom built into the vehicle.

John Vinh

Is there a way to think about kind of the range of incremental content?

Jeff Palmer

Well, what I can do is I can kind of give you a sense of where we're at today. So, on average, a automotive microcontroller, which is kind of the run of the mill product in the industry, can be in kind of the mid-single digit, call it $5 to $7. So, a zonal product, which there would be multiple zonal processors, think of a zonal processor as something that aggregates physical functions around a car, those processors can kind of be in the mid-teens range. Then you have domain processors. Think of domain processers as functional aggregations, not physical aggregations of functions around the car. Those domain processors, they can be in the mid-20s range, $20, $25, and you would've multiples of those in the car. And then on top of that, you would have what we call a vehicle computer. This is our next-generation five-nanometer product. It's actually a quite complex multi-core product. That product would be probably about $50. And in multiple applications that we've seen, there's multiples of those domain - those vehicle computers for redundancy. And I think what's important to realize, as the software-defined vehicle secular trend evolves, there's not one single architecture that every OEM is adhered to. They all have different ways of kind of skinning the cat, depending on what their pain point is. If you are an OEM as let's say a high volume and wiring harness weight is a key thing to focus on, you might first go towards a domain, I mean, zonal-type product. If you are a more complicated, let's say a premium band product where you really are trying to get more logical control of software, you might first go towards a domain-type product. Over the long haul, we think these different architectures sort of (indiscernible). And so, there'll be different blends across the industry.

John Vinh

Maybe we can switch to EVs. I'm wondering if you could just remind us kind of your position on pure EVs versus hybrids. I think there's a view out there that given that you've got a strong position in hybrids that's helped you kind of weather some of the volatility around EVs more recently.

Jeff Palmer

Yes, so we're actually agnostic between pure electric and hybrid electric. Our content on a pure electric 800-volt vehicle might be something like $120, and that's just on the powertrain. So, let's set that aside for a second. On a hybrid, it might be $60 because the battery pack is lower. Our battery management system, which is our focus product for the electric vehicle market is BMS, Battery Management Systems. And our approach is a system approach which combines precision analog front devices that sit on the battery packs connected with in-vehicle networking technology to a backend processor for doing load balancing.

John Vinh

Do you have a view on just how we should be thinking about kind of the ramp for the EV market? Seems like we kind of got over our skis here. Do you think there's more staying power for hybrids? And then how do you think about kind of the ramp of EVs going forward from here?

Jeff Palmer

Well, I think that this concern about the EV party being over is very much a US Wall Street concern. I think yes, some of the large North American OEMs are struggling a little bit to really put up competitive portfolios, but the Chinese OEMs are doing quite well, and China continues to be where the EV game continues to be quite strong, both on the hybrid side as well as on the pure electric side. Now, that growth in China will have to continue through exporting to Western markets. So, we have to see how that plays out. I think looking at the most recent S&P data, which is about three, four weeks old, they're still projecting China EV sales or unit production to be up at least 20% here, 2023 to 2024. So, that's still pretty good. And China is still about 40% of the total xEV market. That's a combination of hybrids and electrics.

John Vinh

Nice. Maybe we can touch base on the Vanguard deal that you guys recently announced. I think you said when fully ramped, you're looking at 55,000 wafers per month. Can you give us a sense of just how much incremental capacity this Vanguard deal is going to give you?

Jeff Palmer

Yes, so here's a bit of a history maybe I should kind of go through it a little bit, John. So, about 18 months ago when customers were much more sensitive from the supply crunch about sourcing, we realized we had a fairly rich design win pipe portfolio of mixed-signal products across different end markets. And customers were wanting to know, hey, where's this capacity going to come from? And as you know, TSMC is our long-term major foundry partner, and we engaged with them and said, hey, look, we have about $4 billion of incremental annual revenue, which will start to become deliverable, if you will, in the 2027, 2028, 2029 timeframe, more in the LA latter part of that window. And TSMC said, that's great, Mr. NXP, and we're really glad that you used our design kits to design these products, but we don't really have a lot of interest in building greenfield trailing edge mixed-signal capacity, but they're a really good customer, a really good partner. And so, they said, look, what we think you should do is engage with Vanguard, which we own 30% of, and build a joint venture, and we'll help with the technology, with the process kits. You guys can build a Greenfield 300-millimeter facility. That facility's JV was announced in June. There's two phases. The first phase, as you said, John, is 55,000 wafers per month. That will be - we expect it to be fully loaded and up and running in 2029. There is a phase two of that facility. It'll be on the exact same campus, which will add another 45,000 wafers per month. Our ownership of the JV will be about 40%. In the early years, we'll have a little bit higher volume ownership because we're making some prepayments because of these design wins I talked about, but our fundamental equity ownership of the facility will be 40%. Now, long term, there's some benefits from investors’ perspective. So, in the short term, it's cash out. So, okay, but you guys may not be real happy about that, but it's a good investment in the business long-term. And beginning in 2029, we'll see about a 200-basis point benefit to corporate gross margins, and that comes from moving to 300-millimeter waivers, avoided margin, stacking, things like that. And then long-term, this is out in the 2030s timeframe, this facility, this JV, gives us a landing place to take some of the material that we run internally on our 200-millimeter fabs and move it over to the 300-millimeter facility because our current 200-millimeter fabs, we have one in the Netherlands and two in the US, they're 40 plus years old. They're aging out. And so, at some point, we are going to have to rationalize those facilities.

John Vinh

Great. Thanks. Looks like we're out of time. Thanks, Jeff.

Jeff Palmer

Oh, okay. Thank you, everyone. Appreciate it.