NXP Semiconductors N.V. (NASDAQ:NXPI) Q1 2023 Earnings Call Transcript

NXP Semiconductors N.V. (NASDAQ:NXPI) Q1 2023 Earnings Call Transcript May 2, 2023

NXP Semiconductors N.V. beats earnings expectations. Reported EPS is $3.19, expectations were $3.02.

Operator: Good day and thank you for standing by. Welcome to the NXP First Quarter 2023 Earnings Conference Call. Please be advised that today’s conference is being recorded. I would now like to hand the conference over to your speaker today, Jeff Palmer. Please go ahead.

Jeff Palmer: Thank you, Latania and good morning everyone. Welcome to NXP Semiconductor’s first quarter earnings call. With me on the call today is Kurt Sievers, NXP’s President and CEO; and Bill Betz, 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 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 2023.

Please be reminded that NXP undertakes no obligation to revise or update publicly any forward-looking statements. For a full disclosure on forward-looking statements, please refer to our press release. Additionally, we will refer to certain non-GAAP financial measures, 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 first quarter 2023 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. I would now like to turn the call over to Kurt.

Kurt Sievers: Thanks very much, Jeff and good morning, everyone. We appreciate you joining our call today. I will start with a review of our quarter one results and then discuss our guidance for the second quarter. So, let me begin with quarter one. Our revenue was $121 million better than the midpoint of our guidance with the trends in all the end market segments performing better than our expectations. Taken together, NXP delivered quarter one revenue of $3.12 billion, essentially flat year-on-year, while we continue to maintain our distribution channel inventory at a 1.6 months level, which is well below our long-term target. Non-GAAP operating margin in Q1 was 34.8%, 50 basis points above the midpoint of our guidance, so 90 basis points below the year ago period.

Year-on-year performance was a result of flattish revenue, combined with better gross margin offset by higher operating expenses. Now, let me turn to the specific trends in our focus end markets. In automotive, quarter one revenue was $1.83 billion, up 17% versus the year ago period and above the midpoint of our guidance. In Industrial & IoT, quarter one revenue was $504 million, down 26% versus the year ago period and near the high end of our guidance. In mobile, quarter one revenue was $260 million, down 35% versus the year ago period and near the high-end of our guidance. And finally, Communication Infrastructure and Other, quarter one revenue was $529 million, up 7% year-on-year and above the midpoint of our guidance. During that first quarter, after a slow start, we have seen modest incremental improvement in our China-exposed businesses, which are primarily served through the distribution channel.

And this was particularly true for our Industrial & IoT and mobile businesses. At the same time, we saw solid demand in our North American and European business across all market segments. Now, I will turn to our expectations for the second quarter 2023. We are guiding Q2 revenue to $3.2 billion. While this is down about 3% versus the year ago period, it represents a sequential resumption of growth to about 3% at the midpoint. At the midpoint, we anticipate the following trends in our business. Automotive is expected to be up in the high single-digit percent range versus quarter two 2022 and up in the low single-digit range versus quarter one 2023. Industrial & IoT is expected to be down in the mid-20% range year-on-year and up in the high single-digit percent range versus quarter one 2023.

Mobile is expected to be down in the low 30% range year-on-year and to be flat on a sequential basis. And finally, Communication Infrastructure & Other is expected to be up about 10% year-on-year and up in the mid single-digit range sequentially. In summary, as we progress through 2023, we do see a continued solid demand environment in our automotive, core industrial and communications infrastructure businesses, while our consumer, IoT and mobile business are stabilizing. We believe the severe shortages, which we have experienced over the last 2 years, should subside as we progress towards the end of this year, with now only about a third of our portfolio with lead times greater than 52 weeks. This is down substantially from prior periods. However, we continue to still be supply constrained in several specific technology nodes, primarily for the automotive and core industrial segments.

In addition, we are experiencing higher input cost. Hence, we continue to execute our consistent pricing policy, which is to pass along the cost increases to our customers, while not pairing our gross margin. Within Automotive, we see a combination of positive tailwinds continuing throughout the year. These includes the ongoing secular adoption of xEV drivetrains and ADAS as well as NXP-specific content and price increases. Third-party research firms anticipate a modest increase year-on-year of global car production, while at the same time we believe there are pockets of elevated inventory held at some select Tier 1 auto suppliers due to the golden screw issues, which have plagued the extended auto supply chain. In Industrial & IoT, we expect relative strength in the core industrial submarkets as our products enable critical infrastructure and companies to be more efficient.

However, while the consumer IoT business is stabilizing, a more significant growth will be dependent on a cyclical rebound, especially in China. In the Mobile segment, we continue to navigate through a sub-seasonal trough in the first half of this year. However, we do anticipate normal premium model releases in the second half to help resume growth. And lastly, in Communications, Infrastructure & Other, we are further improving our supply capability against growing sector demand, specifically in our RFID tagging solutions and against pent-up demand for secure card solutions. On the other hand, our RF power business remains lumpy and growth this year is limited to 5G build-outs in India. Our guidance for the second quarter contemplates that we maintain the 1.6 months channel inventory level.

And yet, we may start increasing this level if and when we see consistent strength in channel sell-through into the second half of this year. And overall, we are very well positioned with on-hand inventory to satiate a possible rebound in demand as it emerges. In summary, the combination of our first quarter results, the guidance for the second quarter and our early views into the second half of the year leads us to believe that total revenue for the second half of the year will be greater than the first half. Despite our cautious optimism, we do acknowledge the ongoing uncertainty in the demand environment. Therefore, we will continue to be very disciplined and manage what is in our control and stay within our long-term financial model. And with that, I would like to pass the call over to you, Bill, for a review of our financial performance.

Bill Betz: Thank you, Kurt and good morning to everyone on today’s call. As Kurt has already covered the drivers of the revenue during Q1 and provided our revenue outlook for Q2, I will move to the financial highlights. Overall, our Q1 financial performance was very good. Revenue was above the high-end of our guidance range. And both non-GAAP gross and operating profit were above the midpoint of the guidance. Now, moving to the details of Q1, total revenue was $3.12 billion, essentially flat year-on-year, while $121 million above the midpoint of the guidance range. We generated

Operator: This is your operator, and you are live.

Kurt Sievers: Great. Bill, why don’t you continue? Sorry about that folks.

Bill Betz: So let me start now moving to the details of Q1. Total revenue was $3.12 billion, essentially flat year-on-year, while $121 billion above the midpoint of the guidance range. We generated $1.82 billion in non-GAAP gross profit and reported a non-GAAP gross margin of 58.2%, up 60 basis points year-on-year and 20 basis points above the midpoint of the guidance range. Total non-GAAP operating expenses were $728 million or 23.3% of revenue, up $40 million year-on-year and up $15 million from Q4, modestly above the high-end of the guidance range, driven by variable compensation and slightly higher R&D investments. From a total operating profit perspective, non-GAAP operating profit was $1.09 billion and non-GAAP operating margin was 34.8%, down 90 basis points year-on-year, though above the midpoint of the guidance range, reflecting solid fall-through on the increased revenue level versus the guide.

Non-GAAP interest expense was $76 million, with non-GAAP income tax provision of $167 million, consistent with the high end of the guidance due to better profitability reflecting a non-GAAP effective tax rate of 16.6%. Non-controlling interest was $8 million and stock-based compensation which is not included in the non-GAAP earnings was $99 million. Taken together, this resulted in a non-GAAP earnings per share of $3.19, which is near the high-end of our guidance range. Turning to the changes in our cash and debt, total debt at the end of Q1 was $11.17 billion, flat sequentially. The ending cash position was $3.93 billion, up $85 million sequentially due to the cumulative effect of higher working capital, CapEx investments, capital returns and cash generation during Q1.

The resulting net debt was $7.24 billion and we exited the quarter with a trailing 12-month adjusted EBITDA of $5.46 billion. The ratio of net debt to trailing 12-month adjusted EBITDA at the end of Q1 was 1.3x and the 12-month adjusted EBITDA interest coverage was 16.4x. During Q1, we paid $219 million in cash dividends, which represented 35% of cash flow from operations. Due to the uncertain macro environment and the recent liquidity issues in the regional banking sector, we paused our share repurchases during Q1. However, we plan to resume buybacks in Q2 and our capital allocation strategy has not changed. We plan to return 100% of excess free cash flow back to the owners of the company. Turning to working capital metrics, days of inventory was 135 days, an increase of 19 days sequentially and distribution channel inventory was 1.6 months or 49 days.

When combined, this represents approximately 184 days. As mentioned during the last earnings call, our inventory strategy is to manage both on hand and channel inventory together to better serve our customers and prevent excess finished goods inventory on our balance sheet and/or in the distribution channel. Our goal is to only ship products into the distribution channel that have a high likelihood of selling through in the current quarter or is being pre-staged if needed for customer deliveries in the next quarter. From an internal standpoint, we are comfortable supporting approximately 140 days of inventory on the balance sheet, so long as we hold the channel at 1.6 months or 49 days. As the channel inventory returns to the long-term target of 2.5 months or 75 days, we would correspondingly lower our balance sheet inventory.

In Q1, the inventory flexibility on the balance sheet enables us to deliver an extra $120 million of revenue by leveraging the die bank inventory on hand. Moving on to days receivables, it was 31 days, up 5 days sequentially. Days payable were 68 days, a sequential decrease of 9 days due to timing of material receipts. Please note, beginning in Q1, we reclassified certain payables amounts to other current liabilities to better reflect true payable trends. Taken together, the cash conversion cycle was 98 days, an increase of 33 days versus the prior quarter as we leverage the balance sheet to avoid over shipping into the channel. Cash flow from operations was $632 million and net CapEx was $251 million, resulting in non-GAAP free cash flow of $381 million or 12% of revenue.

The reduction in free cash flow quarter-on-quarter is primarily due to increased working capital needs as previously noted. Our long-term target has not changed and we are focused on driving non-GAAP free cash flow margin to greater than 25%, a level we demonstrated in the second half of 2022. Turning now to our expectations for the second quarter, as Kurt mentioned, we anticipate Q2 revenue to be $3.2 billion plus or minus $100 million. Furthermore, given our manufacturing cycle times and the current demand environment, our guidance contemplates maintaining channel inventory at a 1.6 month level, though we may move this upward pending improved market conditions. At the midpoint of our revenue outlook, this is down 3% year-on-year and up 3% versus Q1.

We expect non-GAAP gross margin to be flat sequentially at 58.2%, plus or minus 50 basis points. Operating expenses are expected to be $760 million plus or minus about $10 million, reflecting annual merit increases. Taken together, non-GAAP operating margin will be 34.5% at the midpoint. We expect non-GAAP financial expense to be $69 million, and the non-GAAP tax rate to be 16.5% of profit before tax. Non-controlling interest will be $7 million. For Q2, we suggest for modeling purposes, you use an average share count of 261.2 million shares and a CapEx rate of 8% of revenue. Taken together at the midpoint, this implies a non-GAAP earnings per share of $3.28. In closing, I would like to highlight the key themes for this earnings cycle. First, we will continue to manage our inventory as a combination of internal and channel inventory.

This enables us to better serve our customers’ requirements, prevent excess inventory buildup in the channel and supports our outlook for the second half revenue of 2023 to be greater than the first half. Second, the Q2 guidance contemplates internal factory utilization to be in the mid-70s range, which is modestly down from the low 80s in Q1. We believe operating our factories at a more reasonable utilization level enables better flexibility and improved throughput. Despite the lower utilization level, we anticipate our gross margin to remain at the high-end of our long-term model for the remainder of 2023 driven by improved product mix. Thirdly, we are holding more cash on the balance sheet to enable greater flexibility. This includes options around the timing and magnitude of share repurchases, cash dividends or the ability to retire debt early as well as any small tuck-in acquisitions, all of which can be funded with cash on hand.

Finally, we will continue to be very disciplined to manage what is in our control and stay within our long-term financial model. I would like to now turn it back to the operator for questions.

Q&A Session

Operator: And our first question will come from C.J. Muse of Evercore. Your line is open.

C.J. Muse: Yes. Good morning. Good afternoon. Thank you for taking the question. I guess first question, I was hoping you could speak to perhaps pricing tailwinds in 2023. You told us in January that you saw a 14% increase for the overall business. And obviously, you’re not going to update each quarter. I get that. But just curious, embedded in your outlook for a stronger second half versus first half, how are you thinking about the impact of higher pricing as it relates to your higher input costs? And is that something that is broad-based across all segments? Or is that something that we should be thinking about to just specific segments?

Kurt Sievers: Thanks, C.J. So no, we don’t see headwinds from pricing throughout this year. I would actually indeed say it’s probably on the other side of that, since we continue to experience growing input cost, and we stay absolutely rock solid with our pricing policy, which has been and continues to be to pass on all of the increased input cost in order to keep our gross margin percentage protected. So from that perspective, there will continue to be price increases this year. So no headwinds here. It’s actually a tailwind. And yes, we will only detail out how big that tailwind is going to be by early next year. So just like we did this year and the year before. Now when you think across the segments, I think that was the second half of your question.

How does it go into the different segments? I’d say directionally, this is pretty simple and straightforward. It is a function of supply and demand and the – say, the supply shortages, as I think I mentioned in my prepared remarks are most persistent in automotive and core industrial. So those are then also the two segments where the pricing sees the biggest tailwind continued into this year or throughout this year. In general, it’s also important to note, C.J., that a large part of our business is actually anchored on annual price negotiations, which is anyway an annual price for the whole year where we don’t touch that through the year. So in short, no headwind from pricing. What is contemplated in what we said about the second half being larger than the first half in terms of revenue in this year is based also on continued price increases.

C.J. Muse: Very helpful. As my quick follow-up, your OEM sales grew to 51% of total sales versus 45% a year ago. Is that simply a function of kind of mix shift to auto industrial or is this a permanent shift that we should be thinking about for NXP?

Kurt Sievers: No, that was actually a function of the weakness of China in Q1. As we spoke on the last call, we had the significant weakness to start with in the quarter one in China. China is largely distribution for us and a large part of our China business is then again with the industrial IoT and also automotive business. And this is why the distribution part of the business came out so much weaker relatively speaking, through the first quarter. So no, this is not going to be a permanent thing, but it’s been a direct impact and consequence of this Q1 weakness in China.

C.J. Muse: Thank you.

Operator: And our next question will come from Ross Seymore of Deutsche Bank. Your line is open, Ross.

Ross Seymore: Hi, guys. Thanks. I only have two questions. I wanted to just talk about the Auto segment. Kurt, you just mentioned about still some shortages there. It’s great to see significant upside in everything other than auto. Can you just talk about a little bit of what you’re seeing on the demand side in Auto? Is it really just supply limited? Is that the reason that it was a great quarter, but didn’t upside as much as the others? Just puts and takes on end demand versus supply, please?

Kurt Sievers: Yes. Thanks, Ross. Well, I actually felt Q1 in Auto was a great quarter. I think we did 17% year-on-year growth, which is above the high end of our long-term revenue growth guidance. Indeed, the upside in Q1 in Auto was all gated by supply capability. That’s indeed a matter of fact. Going forward, the remaining shortages, which we see across the company are largely in automotive, a little bit also in core industrial, but the more material part of the shortages indeed continues to be in Automotive, such that through the year, I’d say the growth is really sitting on the drivers, which we have discussed before. It is continued content increases, which follows the xEV penetration and ADAS penetration. I’m pretty damn sure that NXP continues to gain share in automotive.

It is pricing as I talked to C.J. earlier, which is in automotive quite vivid. And going forward, I hope that the supply/demand situation, Ross, will normalize through the second half of this year, including Automotive.

Ross Seymore: That’s a perfect segue to my second question and that’s on the utilization rate in the inventory, I was a little surprised that the inventory kind of did what you guys expected it to despite revenues beating so nicely. And then you’re talking about taking utilization down while you’re simultaneously sounding significantly more optimistic about the demand conditions, your ability to grow half over half, etcetera. Can you help us reconcile how the utilization/inventory versus conservatism versus more optimism on demand balance out?

Bill Betz: Sure, Ross. Let me take that. So our utilizations, as mentioned, are running now in the mid-70s versus, again, last quarter, low 80s, and then they were in the 90s in Q4 and high 90s. And we think the sweet spot is around probably 80%, 85%. We’re a bit below that at the moment as we’re trying to make sure we have rebuilt several of our buffer areas where we get inventory or produce inventory internally. So we have that all in strategic die bank form and ready to take on any new orders within the quarter and service them in that period. When it relates to our inventory, let me just help bridge that a bit. Again, we’re holding about – we’re comfortable holding about 140 days. We’re at 135 today. And if you think about it, we have 25 days we’re holding where we could actually put it into the channel if we decide to do so, but we’re not.

We are being very cautious here. We’re only looking at when product sells through and when the market improves. So again, that’s about 25 days off of that 135 or off that 140 base. Then we have another 10 days, I would say, internally, which we call our strategic inventory as we continue to align our internal factories. The CapEx that we’re spending today is around 8% and 75% of that CapEx is linked to our internal factories as we get them really focused on our IP proprietary technology. And finally, to be honest with you, we like to hold another 10 days to be able to service the customer upside orders within the quarter, and we feel comfortable with that versus the 95-day target that we set out during Analyst Day. So I think the way to think about inventory, our internal inventory, we will probably work it down throughout 2023.

By running our front-end internal utilizations in the mid-70s, we will continue to adjust some of our foundry purchase orders and obviously, servicing the higher revenue and Kurt commented that the second half of 2023 will be larger than the first half.

Ross Seymore: Thank you.

Operator: And our next question will come from Stacy Rasgon of Bernstein Research. Your line is open.

Stacy Rasgon: Hi, guys. Thanks for taking my question. I also wanted to ask about Auto. So I know you’re talking about shortages still, but you also mentioned pockets of inventory out in the channel. I think this is the first time I’ve actually heard you directly mention auto build-outs in the channel. Could you give us a little more color on that? What kind of products – how much of your revenue was in those categories? And are you seeing any pause in those areas given where those inventory levels are?

Kurt Sievers: Hey, Stacy, no, the way you phrased it now sounds much, much larger than what I tried to describe. What we do see as a very few select Tier 1s, it’s not about OEMs, it’s about the Tier 1 suppliers. It’s pockets of inventory on those products, which were suffering as a surplus from the golden screw problem. You remember that over the past 2 years, we consistently had those situations where one part was missing, other parts were available. And then those parts were piling up a bit more before they got flushed through when the missing part came on. And from that period, there seem to be a few pockets, but it’s not structural that I could say it’s certain products or a certain amount. But there seem to be a few products at a few select Tier 1s which see somewhat elevated inventory.

Now at the same time, there is now more and more of a discussion in the industry about the target size of inventory, which the Tier 1 should hold. And from what I’m witnessing is that the automotive OEMs, so the car companies are actually quite diligent in asking for elevated inventory levels to the Tier 1s anyway going forward. So now we have to figure out to what extent actually maybe these elevated pockets, which I talked about, are actually used to just satisfy what is being needed going forward anyway in terms of somewhat elevated inventory levels for safety reasons, for supply chain safety reasons in the industry. So it’s a little bit, Stacy, a very few customers. So, nothing dramatic, I mean I just mentioned it because – we talk about the SAAR growing by, I think, close to 4% this year.

And I just wanted to put it in balance because there might be a tiny little bit of a headwind from those inventory levels. But all of that, just to be very clear, will not hinder the automotive business this year to grow and actually to grow substantially year-on-year.

Stacy Rasgon: Got it. Thank you. That’s helpful. For my follow-up, I wanted to ask about China. So it does sound like you worked through the China Dead Sea issues that you had mentioned on last quarter’s calls. Would you characterize this as a China recovery? Are you actually seeing recovery or is it maybe a little too early to jump that far? Is it more just like little green shoots or like what exactly are you seeing in China relative to what you were seeing last quarter?

Kurt Sievers: Yes. Yes, Stacy, I think it’s too early to make such a statement. We have seen a modest, gradual improvement throughout the first quarter from a very slow start, I mean, through Chinese New Year and these elevated infection levels in the first few weeks. It just came modestly up. I would clearly not say and none of our forecast and guidance comments we are making today would be based on that. I would clearly see a sharp rebound. We don’t see this. And again, our numbers are also not based on that, but by the way, Stacy, just also connecting this to your first question. Mind you that our automotive business is also 40% in distribution. So when I talk about these pockets of inventory, they are in the 60% of the automotive business, which goes through direct.

But another large chunk is actually the 40% through distribution and that is controlled through what Bill explained earlier through our disciplined channel management at 1.6 months. I mean just to put it in perspective.

Stacy Rasgon: Got it. That’s helpful. Thank you, guys.

Operator: Our next question will come from Vivek Arya, Bank of America Securities. Your line is open.

Vivek Arya: Hi, thanks for taking my questions. My first one, Kurt, is about half-over-half growth because you mentioned it in your remarks. So if I exclude 2020, second half sales for NXP have grown at least around 5% to 6% half-on-half. Is that the kind of expectation we should have about second half? And what do you think is driving that? Is it just seasonality? Is it China coming back? Is it pricing increasing half-on-half? Just if you could help us set the models in the right place on a conceptual basis about what kind of expectation? And more importantly, what is driving that growth in the second half?

Kurt Sievers: So Vivek, I need to disappoint you a little. I will not size it here. I mean you know that we only guide the next quarter. Yet, I want to give you a maybe a few anchor points. Clearly, the seasonality in Mobile with the premium models ramping in the second half will support that growth of half two over half one. I mean that’s one element. The other element I would mention here is indeed increasing supply capability, and it is clearly in auto and core industrial as we discussed earlier. But it is also in comms infra. Within the comms infra segment, we have this RFID tagging and secure card business, which continues to benefit this year massively from finally supply becoming available. We had actually deprioritized the business through the past 2 years.

And now we can finally serve that secular demand in RFID and quite a bit of pent-up demand in the secured cards business, so that together with the Mobile seasonality will drive the half two over half one growth.

Vivek Arya: Got it. And then just one more on automotive and then just the state of play, when we look at the end market, right, we see a premium U.S. EV maker cutting prices, we hear sluggish demand in China. So how should we reconcile all those end market data points, Kurt, that are a lot more cautious and conservative because of macro factors versus the strength that you and your peers are reporting when it comes to automotive semiconductor demand?

Kurt Sievers: Well, it really goes back to content increase in the first place. And the latest data I have about xEVs, which is one of the two main drivers for content increase is that the number of xEVs in absolute terms globally this year will grow like 34% over last year and it will then hit the 34% portion of the total SAAR. So 34% or just a bit more than third of the total SAAR this year will be hybrid or fully electric. I mean this is a massive move. And by the way, yes, there are shifts. I mean, clearly, there is a wave of success of local Chinese OEMs. You might have seen that some of the Western companies are losing grounds with electric vehicle sales in China against local companies. Now we are perfectly hedged. So we are just as exposed to the Chinese OEMs as we are to the Western ones.

So content increase is the main move, there is still also a forecast for an overall SAAR growth. I think the latest number I had seen from S&P was, I think, 85 million or 86 million, so somewhere in that neighborhood, which is a growth of about 4% over last year. So even the underlying SAAR, if you take it all together, xEVs and combustion-engine cars, is also growing. And that’s actually the reason why this business keeps going, Vivek. So I don’t find it that’s surprising.

Vivek Arya: Thank you, Kurt.

Operator: And our next question will come from Matt Ramsay of TD Cowen. Your line is open.

Matt Ramsay: Yes. Thank you very much. Good afternoon. Good morning, everybody. Kurt, I wanted to revisit quickly the question of pricing. And you were very clear on your comments, particularly in the auto business to what pricing will do for – or you expect it to do for the remainder of the year. But I think though – the question I get a lot is, eventually, when we get a point when lead times stabilize, input costs stabilize and maybe come down a little bit, how are you thinking about long-term pricing in your auto business? Are we going back to the normal price downs from a much, much higher base and a lot of these input cost increases you view as permanent? There is a little bit of angst in the system, I think that what goes up will come down. And I just wondered if you could address some of that, please. Thanks.

Kurt Sievers: Yes. So on the pricing, especially in auto, or I would actually extend this question to all those areas where we’ve had the most significant shortages. It is important to understand where the price increases came from in the first place. They came from a structural, significant CapEx investment in order to cater for new capacity in mature nodes. So, most of that is in the 16-nanometer to 180-nanometer area. And a lot of CapEx has been spent, but continues to be spent also through the next few years and the depreciation of that additional capacity, which became necessary as we all painfully witnessed over the last years, the depreciation of that is going to sit on all of these products across the industry. So, my estimate here is that, yes, pricing will of course plateau at some point.

And then maybe when supply and demand will have normalized we will go back to what we had before this situation, which was a small, single-digit ASP erosion year-over-year, but that is not falling back to the old price levels. It is from the new level, which we have achieved in over 3 years of sequential price increases.

Matt Ramsay: Thank you for that Kurt. Very clear. Bill, for my follow-up, I wanted to ask about inventory levels. I have kind of made the observation that oftentimes your channel inventory being below the long-term target. And then the on books inventory may be increasing. Those get discussed kind of in isolation. And I wonder if you could talk a little bit about it holistically, just that roughly speaking, the inventory days of full NXP inventory are roughly flat, just more on books than in channel and gives you a bit more flexibility. And I guess the long-term question is, what’s the real incentive to go back to the old mix? Why not just keep the ratios relatively close to where they are today given the flexibility it gives you? Thanks.

Bill Betz: Yes. The whole idea of managing the channel is really through understanding real demand in the market. And at the end of the day, what you want to do is put inventory on the shelf that’s going to fast turn versus if you put inventory on the shelf, it stays there then eventually you have to get discounted. It uses real good real estate and so forth. So, what we want to do is making sure we are only shipping product into the channel that is fast turning is the way to think about it. And you are right, the way you think about it is the same way we do. We combine both and basically holding the same amount of inventory combined, and we are just trying this new strategy – actually, we changed this strategy from lessons we have learned in the past because at the end of the day, it’s all about real demand.

Kurt Sievers: And let me add, Bill. I think we will enter this now possibly relatively soon. As we emphasized in our prepared remarks as soon as we see a more consistent uptick in the sell-through trends in the channel, we will increase from the 1.6 months levels. And mind you, we speak about the $500 million delta when we would go from 1.6 months to 2.4 months or 5 months. And again, we are having the attention to fill back to that level, but again, in line with industry demand coming back. But those $500 million, we basically have that, and we will get it into the channel as soon as the demand is coming. In the end, that will be required to make sure we can gain market share through distribution the moment the industry ticks up.

Matt Ramsay: Thanks guys. Very clear.

Operator: And one moment for our next question. And our next question will come from Gary Mobley of Wells Fargo. Your line is open.

Gary Mobley: Hey guys. Thanks for taking my question. I presume that your backlog continues to trend down, but I was hoping that you can give us an update where you stand today with weeks of backlog, the durability of that backlog and whether or not you are still sold out in automotive based on your available supply – sold out through the remainder of the year I should add.

Kurt Sievers: Hi Gary. So, no, we never talked about the size of the backlog because I really tried to be sure you all understand that we consider that backlog number misleading and that it’s been misleading since the beginning of the supply chain situation because, sure, we and I guess everybody else has had double and triple orders in there. So, I felt it never made sense to speak about the backlog, the size of that backlog as a metric to get a feel for future growth. So, that’s why, no, we will not speak about the backlog. What – however it comes back to what I think you are asking for is in automotive, the NCNR orders. So, yes, the largest part of our automotive business has been and continues to be covered by NCNR orders for this year.

The size of that NCNR order backlog has not changed at all. We also cannot ship more, I mean it is what it is. And there is always mix changes from left to right and stuff, but the size of it is the same it has been before, and we just executed down.

Gary Mobley: Thanks Kurt. And a follow-up, I want to ask about changing behavior following a 3-year period of supply chain shortages in the automotive end market. And so under the idea that the automotive OEMs have learned a lesson and will work more collaboratively with chip companies like yourself, perhaps the big, bigger. And perhaps you can expand further your market share lead by collaborating more closely with these automotive OEMs. Is there a way to quantify it or qualify the impact to that and whether or not that has any validity?

Kurt Sievers: I think you have a really good point here. Very clearly, the rate of collaboration and also the depth and intensity of collaboration from logistics all the way to innovation and new design wins has significantly jumped up between us and the auto OEMs. That indeed also leads to direct deals, which we are cutting with these companies on a very long-term basis where the principle is often that we give supply assurance against a very long-term demand assurance from the OEMs. And yes, I believe there is a bit of a winner takes it all game here because if I put myself into the shoes of the OEMs, they cannot play with six or eight different semiconductor companies. They will focus down on a few select leaders, and you can be sure NXP is one of them.

Gary Mobley: Thanks Kurt.

Operator: And our next question will come from Blayne Curtis of Barclays. Your line is open.

Blayne Curtis: Hey guys. Thanks for taking my question. Bill, I wanted to just double click on the gross margins. It’s actually kind of quite impressive that your utilization is down that much and it’s flat. So, maybe just walk us through the pieces again. Obviously, mix per segment, I wasn’t sure if auto is accretive to that mix. I think mobile going down probably helps. But I also kind of wanted to understand your external loadings that you kind of mentioned that you might selectively bring that down, if you can comment on that as well.

Bill Betz: Sure. Let me – the major drivers is first, again, we expect favorable product mix. What we see, obviously, and what we are building to is favorable, and we see that in our forecast. Then it’s clearly being driven by the customer orders we are serving. And then we talked about this new product introduction. We are starting to see some of that. But again, longer term, that will kick in a couple of years out to continue that richer mix for the company. Now second, you have to remember our fixed variable cost structure, which is approximately 30% fixed and 70% variable and this has significantly improved versus the last down cycle and over the last decade. And then finally, we are realigning our internal factories.

And you have to remember, we service about 40% of our wafers, which two-thirds of our internal factories support auto and industrial IP proprietary technologies. Versus the past, we would build bulk CMOS and so forth, which would disturb the utilization of our factories. So, think about the equipment that we are putting in, very sticky, very specific to our core IT technologies that service basically auto and industrial, the two fastest growth markets over the next decade that we are going to serve.

Blayne Curtis: Got it. And then I wanted to ask you on the Comms segment. I think Kurt mentioned RFID being the big driver for the year. But is that the same driver for the strength you are seeing in March and June off the bottom?

Kurt Sievers: Yes, it is RFID and secure cards, which are really leading here from a growth perspective. That doesn’t mean that the other stuff is not growing, but say the incremental additional growth really comes from supply into RFID and secure cards. But again, the difference between the two is that in RFID, it’s really secular growth, which we have been working towards for many, many years, and now a lot of these projects are unfolding. Whereas in the secure cards, it’s somewhat more pent-up demand, which will separate at some point, tut the lion’s share is RFID.

Blayne Curtis: Thanks guys.

Operator: And one moment for our next question. And our next question will come from William Stein of Truist. Your line is open.

William Stein: Great. Thanks for taking my question. Congrats on the very good results and good outlook. The results came better than you expected. And I want to make sure I understand. I think at the beginning of the call, you said that the primary driver was an improvement in China. Is that correct? And I am trying to reconcile this with the idea that distribution was down as a percent of sales because I thought most of what goes on in China for you guys is through the channel. Is it just the expectations in the channel and in China were so low you still came in low, but that’s what improved through the quarter, am I getting that right?

Kurt Sievers: Yes. So, I would say one part of it is China, where indeed it was less bad than feared in mobile and industrial IoT. That’s, I think pretty much what you said. We took a cautious stance here because we had a really slow start in the beginning of the quarter. And then gradually, it improved a bit more than what we were fearing it would. However, the other side is more supply, which came into auto and comms infra. So comms infra, as I just explained to Blayne. And then also in auto on a more broad-based that also helped the outperformance. At the same time, it’s really important to see here that this $121 million more revenue we did, did not move the channel MOS up an inch. So, that was really true good revenue, all the $121 million. But yes, a part of it in China was a say, a better performance than we were fearing how China’s demand would develop.

William Stein: I would like to follow-up with giving you an opportunity to talk about some of the growth drivers that I don’t think have been as prominent in this call as in the past. Any highlights in terms of adoption of some of these new technologies. In autos, you have talked about high-def radar domain and zonal controllers and you have talked about Ultra-Wideband in a couple of different end markets. Maybe highlight some of the more significant content drivers in the near-term and longer term.

Kurt Sievers: Yes. I think in RADAR and I think it’s also in our press release, we are very properly launched now the industry’s first 28-nanometer based one chip radar for automotive, which is moving in production now, which is great progress. I think the – this one market research company, which covers automotive radar, Yole clearly presented us now as the number one in automotive radar in – for last year. So, the numbers are out. So, now this whole thing is who is leading in automotive radar is clear now. It’s documented, we are number one. Then today, we had a very nice press release together with NIO, which is one of the smart electric car startups between California and China, which is using our 4D imaging radar, which is the high end of radar, which is a 300-millimeter – sorry, 300-meter distance measurement including object classification.

And Bill, I remember you and I are speaking about this years ago as a dream in innovation. Now, the thing is out, and it sits in these NIO cars. Then moving to electrification, I think earlier in the call, I mentioned the growing strength of China OEMs when it comes to electric cars. That is very good for our battery management business because we have a strong bias to winning designs in China. So, that’s fast-turning business, fast-turning means for automotive standards, they go pretty quickly from design into production helps a lot our BMS/electrification business. Last but not least, I think you mentioned Ultra-Wideband. Ultra-Wideband is a mixed picture though. The Android adoption continues in the ecosystem to be slower than we had anticipated.

So, that’s a little – I think we said this on the last call already, it’s a little later. That doesn’t mean it doesn’t happen, but it’s a little later. While the automotive side of Ultra-Wideband is actually picking up the pace now enormously, so we see very, very nice growth on the Ultra-Wideband side in cars, where we also haven’t seen a single competitor yet. So, it’s really an NXP only story.

William Stein: Great. Thank you.

Operator: And one moment for our next question. And our next question will come from Toshiya Hari of Goldman Sachs. Your line is open.

Toshiya Hari: Hi. Good morning. Thank you so much for taking the question. I wanted to follow-up on China. Kurt, you talked about a modest recovery in the region. I was hoping you could speak to linearity in the quarter from either bookings or revenue recognition perspective? And then I guess more importantly, when you guys talk about the second half recovery in your overall business, the second half being higher than the first half, does that contemplate an increase in channel inventory from 1.6 months to something above 2 months, or do you have visibility in half-over-half growth without any increase in channel inventory?

Kurt Sievers: Yes. Toshiya, so on the first half of your question, we will not provide any within segment – within quarter details. So, it has gradually improved through the quarter. I mean let’s leave it here. The second half of your question is really, really important. The answer is no. Our Q2 guide of $3.2 billion does not need or comprehend any increase of our general inventory. So, to be very specific, it sits again on 1.6 months of general inventory. However, we will take the liberty to increase the channel inventory if and when we see a trend that the sell-through goes strong into the third quarter in order to prepare for that uptick. But then we will also make more than $3.2 billion revenue. So, the $3.2 billion, which are in the guidance, are connected with 1.6 months. We might still go higher, but then we will also print the higher revenue.

Toshiya Hari: Understood. Thank you. And then as my follow-up, I just wanted to clarify on lead times. You mentioned that in Q1, I think roughly a third of your products had lead times of 52 weeks or longer. Where do you expect that number to be exiting the year? And I was hoping you could speak to average lead times for your portfolio as well. What your target is, I guess coming out of this pandemic?

Kurt Sievers: Yes. This is a – it’s a tricky question because the lead times are a function of the amount of NCNR orders we have. I spoke earlier about the fact that our automotive business, which is the lead example for this is largely covered by NCNR orders. And that simply means that whole product portfolio for these customers, if they now ask for an additional order, of course they get only a confirmation for next year because it’s already ordered out. So, I mean the way you got to think about this is if all of our business was covered by NCNR orders, all of our business would have 52 weeks later. Now, we don’t have that. It’s only a part of it. But that’s why as long as we stick to the concept of annual – they are based on calendar years, annual NCNR orders, we will have a sizable part of our portfolio sitting on 52-plus weeks lead time.

It’s just a consequence of the NCNR orders. So, that’s why, to answer your question, it depends is again for calendar 2024, we will enter into the concept of NCNR orders. If we do that – and by the way, I expect that we will do that. We will have still a sizable part of the portfolio with lead times above 52 weeks, too. Now operator, I think we got to terminate the call here. We are at the top of the hour. So, I just want to thank you all for your attention through today’s call. I trust you felt that we are at a pivotal point in navigating through this cycle, where we see that we are successfully navigating the consumer-oriented weakness in our business and seeing a change in slope of that business, while the core industrial, automotive and also large parts of comms infra continue to be resilient and strong.

And then if we put all of these pieces together, that leads us then to what we said today, which is the second half of this year revenue being above the first half, and now also a guidance into the second quarter where each of our four segments is actually sequentially growing. And with that, I want to thank you all for your attention. Thank you.

Jeff Palmer: Thank you everyone and this will conclude our call for today. Thank you very much.

Operator: Ladies and gentlemen, you may now disconnect.