恩智浦 (NXPI) 2015 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the fourth-quarter and full-year 2015 NXP Semiconductors earnings conference call.

My name is Taria and I am your operator for today.

As a reminder this conference call is being recorded for replay purposes.

Now I would like to hand it over to Mr. Jeff Palmer, Vice President of Investor Relations.

Please proceed, sir.

Thank you, Taria.

Good morning, everyone.

Welcome to the NXP Semiconductors fourth-quarter and full-year 2015 earnings call.

With me on the call today is Rick Clemmer, NXP's President and CEO, and our new CFO, Dan Durn.

If you have not obtained a copy of our fourth-quarter 2015 earnings press release it can be found at our Company website under the investor relations section at NXP.com.

Additionally, we have posted on our investor relations website a supplemental earnings summary presentation and a document of our historical financials to assist in your modeling efforts.

This call is being recorded and will be available for replay on our corporate website.

Our call today will include forward-looking statements that include 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 macroeconomic impact on the specific end markets in which we operate, the sale of new and existing products, and our expectations for financial results for the first quarter of 2016.

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 today.

Additionally, during our call we will reference certain non-GAAP financial measures which exclude the impact of purchase price accounting, restructuring, stock-based compensation, impairment, merger-related costs, and other charges that are driven primarily by discrete events that management does not consider to be directly related to NXP's underlying core operating performance.

Pursuant to Regulation G, NXP has provided reconciliations of the non-GAAP financial measures to the most directly comparable GAAP measures in our fourth-quarter 2015 earnings press release, which will be furnished to the SEC on Form 6-K, and is available on NXP's website in the investor relations section.

Before we begin the call I have a few updates on our upcoming investor events.

On March 1 we will be attending the Morgan Stanley TMT conference in San Francisco.

On March 16 we will be attending Barclays emerging payment conference in New York City.

And, finally, on April 28 we will be hosting our analyst day in New York City.

We will be opening an online register site in a few weeks to enable pre-registration.

I would now like to pass the call to Rick.

Thanks, Jeff.

And welcome everyone to our earnings call today, a quite momentous event making a major milestone in our evolution as a company.

As this is our fourth-quarter and full-year report, I will spend a few moments highlighting fee aspects of our full-year results before moving on to the details of Q4.

The end of 2015 brought to a close a year filled with significant accomplishments and a few challenges for NXP.

During Q4 we successfully completed the merger with Freescale.

The merger creates a powerhouse and positions NXP as the leader in multiple strategic markets.

The Company emerges as a clear market leader in the areas of automotive, microcontroller, and security semiconductor solutions.

As was required to achieve regulatory approval of the Freescale merger, we successfully completed the divestment of the legacy NXP RF power business.

Additionally, we successfully completed the creation of WeEn Semiconductor, our second joint venture in China.

We continue to see China as an exciting long-term opportunity and we will continue to take a creative approach about how to best take advantage of this.

If we look at what both companies anticipated heading into Q4, we are pleased with the outcome of the quarter and feel positive about the opportunities ahead of us.

We were very happy with our profit performance for the quarter.

Both companies were in the expected range on revenue, with Freescale slightly stronger and NXP slightly weaker from the respective midpoint guidances.

However, the year was not without its challenges.

During the second half of the year, similar to our peers, NXP faced an uncertain macro demand environment.

As a result of the weakened demand environment we fell short of our absolute full-year revenue goal, though we continued to outperform the overall industry on a relative basis.

While the overall demand environment in semiconductors is still not clear, we feel positive about the trends and opportunities we see in our combined business.

While Dan will go into the specific financial details of 2015 in Q4, I see the following key accomplishments in our full-year 2015 performance.

First, we delivered strong revenue growth relative to the overall market.

Full-year 2015 revenue was $6.1 billion, up 8% from 2014, including a month of revenue contribution from Freescale.

Within our strategic HPMS segment revenue was $4.72 billion, up 12% year on year.

In Secure Connected Devices revenue was $1.26 billion, up nearly 23% year on year.

In Auto, revenue was $1.34 billion, up just over 17% versus the prior year.

In the newly-named Secure Interfaces and Infrastructure, revenue was $1.1 billion, up 10% year on year.

And lastly, Secure Identification Solutions revenue was $973 million, slightly down year on year.

Revenue from the Standard Products segment was $1.24 billion, down nearly 3% versus the prior year.

Secondly, we continued to improve our overall profitability.

On a full-year basis, non-GAAP operating profit was approximately $1.68 billion, up about 19% versus the prior year, reflecting disciplined expense management and margin improvement.

Even when factoring in the merger-related impacts to interest expense and diluted share count, we delivered strong full-year EPS of $5.60, up 18% year on year.

Lastly, customer reception to the merger has been outstanding.

The original vision of being able to deliver broader, more complete solutions to our customers is being well received.

We continue to find areas where we can address a larger portion of our customers' electronic system requirements.

As just one example, at CES a month after the merger closed we introduced a postage stamp-sized radar solution combining NXP's RF CMOS radar front end and a Freescale ADAS microcontroller.

We have gotten very favorable customer feedback on this product and we feel we are only beginning to scratch the surface of what we see could potentially be accomplished.

Turning now to the specifics of Q4, revenue was $1.61 billion, up nearly 5% year on year and up just over 5% versus the prior quarter.

Looking at our segment performance, HPMS revenue was $1.31 billion, up about 12% from a year ago as well as sequentially.

Now I'd like to review how we will report the Freescale product groups within the NXP operating segment structure.

Our Auto business will include the Freescale auto MCU and the majority of the analog and sensor product groups.

Our Secure Connected Devices will include all of the Freescale general purpose MCU product group.

We have renamed Secure Interfaces and Power to Secure Interfaces and Infrastructure, reflecting the inclusion of the Freescale digital networking in RF power business groups.

And there will be basically no change to Secure Identification Solutions.

Standard Products segment revenue was $271 million, down 18% from the same period a year ago, and just under 17% sequentially.

Please note, during the quarter we completed the creation of the bipolar joint venture, and our Q4 results include only one month of sales, as the final two months were included within the joint venture results.

Turning to our distribution channel performance, as we discussed in last quarter's call, we took specific actions to reduce the inventory in the channel.

In the quarter our sales into distribution were down 22% while sales out of distribution were only down 5%.

Corrective actions reduced channel inventory to 2.7 months of inventory.

In summary, I believe NXP is ideally positioned in the right markets with the right customers and the leading portfolio of solutions.

The merger will result in a significant improved cost structure and broaden our product portfolio, which will provide a major catalyst for customer and shareholder value creation.

Now, before I pass the call on to Dan, I just wanted to welcome Dan, since this is his first earnings call, to NXP, as Dan joins us from Freescale.

We're really looking forward to his contribution going forward.

I'd also like to take just a moment to thank Peter Kelly for all of his contribution to the evolution of NXP and the success that we have achieved to date.

So thank you, Peter.

Dan.

Thank you, Rick.

And good morning to everyone on today's call.

Before I get into the specifics on Q4 and calendar 2015, I wanted to spend a few minutes highlighting the many accomplishments the NXP team has delivered the past several quarters.

Despite the sales challenge in Q4 Rick mentioned, calendar 2015 marked another year of success.

We delivered continued margin expansion and improved operating leverage, generating 18% EPS growth for the Company.

We continued to generate strong cash flow, and $475 million of that cash was allocated to buying back shares.

And we delivered these results in a macro environment that became more challenging as the year progressed.

The year, of course, culminated with the successful completion of the merger with Freescale.

The integration work leading up to the merger close was, in my opinion, world-class on the part of both companies.

Day one was a major success across the globe and we are off to a fast start as a new company.

Rick, Peter, and the rest of the team deserve all the credit for these successes.

In particular, Peter's tireless efforts were instrumental in bringing the merger of NXP and Freescale to a successful conclusion.

Peter has played a critical role in raising the bar and driving financial success of NXP over the last several years.

I have known him for many years.

He has been influential in my own personal evolution as a CFO, and I'm very happy he is going to remain with the Company to help guide our strategy and continue to provide his valuable insight and advice to the management team moving forward.

Finally, I would personally like to thank all our stakeholders, our employees, customers, and shareholders, for their continued confidence in our Company as we navigated through the last 12 months.

Turning now to our performance in 2015, we delivered full-year revenue of $6.1 billion, up 8% versus the prior year, and continued to deliver growth above our peers.

We managed our operating expenses efficiently, driving full-year non-GAAP operating margin of 27.6%, an increase of 260 basis points over 2014.

The excellent work and planning that both the NXP and Freescale integration teams delivered over the past year paid off.

We have clarity on the key initiatives and are rapidly executing on the plan cost synergies.

Lastly, even in light of the influences of the merger on the diluted share count, we delivered very good earnings growth, with non-GAAP EPS of $5.60, up 17.6% year on year.

Moving to the financial highlights for Q4, please note that our published results today reflect a little less than one month of the financial contribution from Freescale.

Given the many moving pieces, we don't plan to break out the individual performance of each company.

Revenue in Q4 was $1.61 billion, up 5.5% sequentially.

We generated $806 million in non-GAAP gross profit and reported a non-GAAP gross profit margin of 50.2%.

Looking at the operating segments, within the HPMS segment revenue was $1.31 billion, up 12.2% over the previous quarter.

Non-GAAP gross margin was 54.6%, 60 basis points above the third quarter due to a richer mix.

HPMS non-GAAP operating margin was 29.2%, a decline of 270 basis points sequentially as we saw a 28% sequential increase on a dollar basis of non-GAAP operating expenses due to the merger.

Within our Standard Products segment revenue was $271 million, down 16.6% versus Q3.

Non-GAAP gross margin was 35.8%, a 40 basis point improvement versus the third quarter.

Standard product non-GAAP operating margin was 23.6%, a 100 basis point sequential decline due to fall through on lower revenue.

Operating expenses were essentially flat quarter-on-quarter.

Total non-GAAP operating profit in Q4 was $433 million and represented a 27% non-GAAP operating margin.

Interest expense was $56 million with cash taxes of $19 million, and non-controlling interest was $17 million.

Taken together, this resulted in a total non-GAAP net income of $341 million for the Company, a 10.3 sequential decline due to the combination of the higher HPMS operating expenses, increased interest expense and cash taxes.

Non-GAAP earnings per share were $1.25, down $0.32 from Q3 due to the previously mentioned items as well as a higher diluted share count.

Stock-based compensation, which is not included in the non-GAAP earnings, was $111 million.

Now I'd like to turn to our balance sheet.

Total debt at the end of Q4 was $9.2 billion with a cash balance of $1.6 billion, resulting in net debt of $7.6 billion.

During the quarter we raised capital through the issuance of a $2.7 billion five-year term loan at an interest rate of 3.75%.

Additionally, we successfully completed the sale of NXP's Legacy RF power business and the creation of a bipolar joint venture called WeEn Semiconductor.

We used the net proceeds from these actions plus the combined cash on hand to finance the cash component of the merger and to refinance certain tranches of Freescale's existing debt.

We are in a very solid position with respect to our debt levels, with our current weighted average cost of debt of 3.91%.

We exited the quarter with a trailing 12-month adjusted EBITDA of approximately $1.96 billion.

Our ratio of net debt to trailing 12-month adjusted EBITDA at the end of Q4 was 3.88 times, and our non-GAAP interest coverage in the quarter was 7.7 times.

Both of these ratios reflect only one month contribution of Freescale profitability.

During the quarter we bought back 1.8 million shares at a cost of approximately $151 million, or a weighted cost of about $83.03 per share.

Our total share repurchase during 2015 were approximately 5.3 million shares for a total cost of just over $474 million, or an average cost of $88.93 per share.

Turning to our working capital metrics, days of inventory were 101 days, receivables were 37 days, and our payables were 71 days.

Taken together, our cash conversion cycle is 67 days.

These non-GAAP measures take into account the effective merger accounting.

Cash flow from operations was $271 million, and net CapEx was $91 million, resulting in non-GAAP free cash flow of $180 million.

Now I'd like to provide our outlook for Q1.

As Rick noted in his prepared remarks, we believe we are operating in an uncertain demand environment which began to materialize in the second half of 2015.

We took specific actions when we provided guidance for Q4, aiming to align our channel inventory to a weaker than anticipated demand environment.

While we have some more work to do on rationalizing our channel inventory, we are making progress.

With this as background, we currently anticipate Q1 revenue will be in the range of $2.15 billion to $2.27 billion, reflecting the first full quarter combination of the two companies.

At the midpoint we expect revenue to be about $2.21 billion in Q1.

Within our HPMS segment we expect revenue to be in the range of $1.84 billion to $1.95 billion.

Due to the combination we will provide high and low revenue estimates for the operating segments.

Next quarter we will return to our normal percentage approach to guidance.

Auto is expected to be in the range of $790 million to $810 million.

Secure Identification Solutions is expected to be in the range of $215 million to $230 million.

Secure Connected Devices is expected to be in the range of $440 million to $480 million.

Secure Interface and Infrastructure is expected to be in the range of $395 million to $430 million.

Standard Products is expected to be in the range of $275 million to $285 million.

We anticipate revenue from manufacturing, corporate and other to be approximately $36 million plus or minus $2 million.

At the midpoint we expect non-GAAP gross margin to be 49.5%.

We expect a slightly more favorable revenue mix though modestly offset by full-quarter effect of the merger and the impact of annual price adjustments.

At the midpoint operating expenses are expected to be about $585 million.

This translates into a non-GAAP operating margin of 23% plus or minus 50 basis points.

Interest expense will be approximately $95 million with the increase due to the higher gross debt balance.

Cash taxes are expected to be roughly $16 million.

Non-controlling interest should be about $10 million.

Stock-based compensation should be about $92 million, which is excluded from our guidance.

Diluted share count is assumed to be 354 million, but could be different depending on share price fluctuations and stock buy backs.

Taken together, this translates into a non-GAAP earnings per share in the range of $1.05 to $1.15, or $1.10 per share at the midpoint of our guidance.

To assist in part with your full-year modeling efforts, we anticipate full-year net interest expense to be about $380 million, full-year cash taxes to be about $80 million, and a normal quarterly run rate on stock-based comp of just under $85 million per quarter.

We will provide an update financial model at our April 28 analyst day.

So, in summary, calendar 2015 was a year of solid achievement for NXP.

We grew the top line and managed our cost structure to deliver strong earnings growth and cash flow generation.

The NXP Freescale combination brought together two great companies whose best days lie ahead.

We become an automotive, MCU, security, and networking powerhouse with significant scale, and the ability to deliver strong earnings growth in the years ahead.

I'm excited to be a part of this team, and look forward to communicating with each of you as we work to unleash the potential of this great combination.

Now I'd like to turn it back to the operator for your questions.

Operator?

(Operator Instructions)

Our first question comes from the line of John Pitzer of Credit Suisse.

Your line is now open.

Good morning, guys.

Thanks for letting me ask the question.

And congratulations on the strong full-year results.

Rick, my first question is just around your growth rate in the December and March quarter relative to peers.

And I understand there is a lot of M&A divestiture messiness, which makes apple-to-apple compares difficult.

And I've got make some assumptions here.

But as we run through and try to come up with apples to apples, it does look like December and March are going to be down both double digits year over year for you, which is a little bit worse than the peer group.

To what extent is that just the issue with the distribution channel?

It sounds like you're going to under-ship to distribution again in the March quarter.

Or is there other things going on?

And, importantly, when would you expect your relative growth rate to return to what's been a more normal of outperformance?

John, first off, I don't think you can look at growth rates on a quarterly basis.

I think you really have to look at that over a more sustained basis.

If we look at annually, I think it's very clear that NXP continued to outperform our peers in 2015, and we feel confident we will continue to outperform the industry in 2016.

If you look at it quarter by quarter, clearly Q4 and Q1 are messy as we bring the two companies together.

I think we were pretty clear that when we went through the combination, that we felt very good about the profitability for Q4 results.

I think when you look at our revenue versus the guidance, versus the range that both companies had published last quarter, NXP was probably a little bit light of the midpoint while Freescale was a little bit stronger than the midpoint.

Frankly, it doesn't matter at that point in time.

We have one company brought together to be able to address our customer solution requirements and we feel like we'll continue to outperform the industry going forward.

Rick, embedded in your March revenue guide, is it still an assumption that you will be under-shipping the distribution channel?

Sell in will be down more than sell through?

John, in the semiconductor industry you're doing good just to get close to a range.

Trying to give you the details behind that relative to what goes into disti and what goes otherwise is probably a bridge too far.

I think what we have to do is be sure that we manage the distribution inventory correctly.

We think we're down in the range of level of inventory that we'd like our partners to have, because that's the reason we pay them that margin, is to be sure they have the inventory there to be able to serve the market.

At 2.7 months we feel good about that even though it's a little bit higher than where we would have been on an NXP RF Freescale basis from a historic viewpoint.

But we actually feel like that's more in line with the range we need to be in.

We clearly have some pockets that are slightly above where we would like for those to be.

One of them that we talked about last time was the aftermarket car radio market, primarily in Asia and China.

I talked about that business, and I think I talked about it not as clear as I should have.

That business is around a fourth to a third from a volume viewpoint of our car infotainment, which again was half of the old NXP automotive business.

If you look at it from a dollar basis, it's more like high single digits, low double digits, but from a volume viewpoint it's a fourth to a third of the volume associated with it.

So they're clearly, in that case our inventory, we were able to bring it down some in the Q4 timeframe, but it's still above the level we'd like for it to be.

That business we definitely saw some improvement associated with it, but we have to get back to a steady run rate basis.

That's all the moving pieces and details that we really can't get into projecting the details of those, John.

It's more about giving you guidance relative to what we see in total and continuing to outperform the industry.

That's helpful.

Then maybe for my follow-up to Dan, just on the OpEx side, again, the compares are difficult because of the M&A, but if I look at a pro forma revenue and OpEx run rate for the combined NXP Freescale in the September quarter, and then look at what you're guiding to for March, it does seem that revenue is down a lot more from that compare than the OpEx is.

Can you help me understand if there is any period costs that are coming into OpEx in the March quarter?

And, more importantly, can you help me understand the cadence at which you can start to realize some of the M&A synergies that you guys have talked about on the OpEx line as we go throughout 2016?

Thanks, John.

I think I'd start by saying both of the respective companies that comprise NXP today I think have great track records in terms of cost discipline and driving an efficient cost structure.

As we take a look at any given quarter, there is going to be lumpiness.

For instance, there is going to be mass costs that come into play some quarters and not in others.

Transitioning into Q1 we always know there is headwinds as it relates to things like Social Security tax.

So, there is a number of moving pieces that create issues like that.

We also know that revenue falls off faster than costs compress, so they don't scale linearly with revenue.

What I will say is, given the track record both companies have, we are 100% focused on driving efficient cost structure, driving cost discipline into the business.

We're making good progress.

And from a full-year synergy target standpoint, I think we have been clear.

We are going to talk about it on a full-year basis and not get into the details of how it profiles.

But we're off to a good start and we are very confident with where we are going to land this company in 2016 with respect to the $200 million of synergy targets.

Thanks, guys.

Appreciate it.

Thank you.

Our next question comes from Ross Seymore of Deutsche Bank.

Your line is now open.

Hi, guys.

Thanks for letting me ask a question.

I wanted to focus on the biggest end market that you have, which is the automotive side.

Lots of concern outside of the semiconductor industry about that peaking from a SAAR perspective.

In general, can you just talk about what you are seeing from a demand perspective in Automotive?

And then if, in fact, SAAR is rolling over what are the items that you think NXP has to offset that with content gain?

Thanks, Ross.

What we see is we continue to see strong demand in the segment from both the US and Northern European manufacturers.

We think that's really fundamental to the growth.

The best thing that we can see for 2016 is we still expect 2% or 3% SAAR growth.

So we don't see it going up, clipping up significantly, but we don't see it falling off.

Demand in Europe continues to be solid.

The demand in the US continues to set records as of the recent input.

And then in China where we had seen the falloff in the fall of last year with some of the government tax incentives, we've seen the smaller car production move back up associated with that.

So, I think that's the fundamentals that we see relative to the industry.

With the discussion about what the implications are if SAARs did not grow, I think the key for us is really our opportunity to focus on the emerging area in ADAS, or assisted driving, because I don't know that it's going to really be pure automated driving near term, but assisted driving, making driver safer, and then making it more secure by providing the enhanced security for the car.

With the security capability that NXP's had historically, and the real product portfolio that we have on a combined basis, we are really in an excellent position to be able to provide security to the car manufacturers and provide a complete secure car.

And we see a lot of interest in that area, especially off of the car hacking that took place several months ago with the car industry and all of the car companies much more interested in that.

When you look at the opportunity about assisted driving, the position we have and the product we announced at CES with the technology from the combined company, the Freescale microcontroller combined with the legacy NXP RF CMOS front end, radar front end, it really puts us in a leadership position to be able to address that with the vehicle-to-vehicle design wins that we've talked about, with the first one ramping later this year for the 2017 model year through Delphi.

And we have won a number of other design wins on vehicle to vehicle.

The strong radar position that Freescale's had historically, combined with the new solution that we talked about coming from CES, and the vision product that Freescale has developed in the past that we can take forward, we think puts us in a leadership position to really be able to address the fastest growing segment of the automotive market, which would be in the assisted or automated driving area.

So, our position there will clearly put us in a different position than just the typical automotive semiconductor shipments.

And when you look at that combined with the security basis, I think that's pretty clear that we should be in a position to out perform just the overall semiconductor automotive market.

That's very helpful.

For my follow-up, if I could switch over to Dan, you gave the leverage ratios, but clearly those were with only the stub from the Freescale side.

Could you give us an update on an adjusted basis where the levered ratios are now?

And then probably more importantly, looking forward, give us an update on the target to get down to that 2 times leverage ratio.

And then after that fact how much cash does the Company plan to hold before returning it to shareholders?

Thanks, Ross.

From a leverage standpoint, you rightfully point out that the numerator includes all of the debt.

The denominator includes partial credit from a profitability standpoint.

And I think where the expectations were set pre-close from a leverage ratio standpoint, we're very close to that in terms of where we sit today at around 2.7 from a net debt to EBITDA perspective.

In terms of the long-term targets, I think it would be premature to get out in front of the analyst day.

We will come back with more specific guidance of how we see those ratios trending over time, and make smart choices with our capital structure with respect to debt and equity.

Thank you.

Thank you.

Our next question comes from Stacy Rasgon of Bernstein Research.

Your line is now open.

Hi, guys.

Thanks for taking my questions.

I know you only want to talk about the synergies on an annual basis at this point, and you don't want to give a trajectory, but I was wondering if you could give us a little more transparency in terms of how much of the cost synergies are actually embedded in the Q1 guidance, at least to give us a starting point.

I think what you are asking fundamentally at the core of that question is to do what we said we wouldn't do, which is begin to parse out the profile of synergy capture throughout the year.

Again, I would stick with my comments that we feel confident about where we're going in terms of overall synergy capture for the year and we feel like we're off to a really good start in that.

I'm not asking you to try to parse anything.

I am trying to get a feeling for our starting point because otherwise it's very difficult to do the comparison to actually know what you are capturing and what you are not.

Is it possible you could give us just a little bit more color on just Q1, like how much is in there?

Stacy, it's Jeff.

I think, as Dan mentioned, I don't think we are going to parse out where the starting point is on the synergies.

As Dan in his prepared remarks said we feel very good that we have identified these synergies.

The teams are off to a fast start, monetizing those synergies.

But, look, as the Company continues to grow and do very well, we will invest in the business.

But the synergies are very identified and we are not going to break them out on a quarter-by-quarter basis.

Though I understand the question.

Okay, thank you.

If I can follow up, I want to ask about your inventory levels, your internal inventory.

If I look at the Q4 combined level on the balance sheet it's about $360 million higher than NXP and Freescale together were in Q3, but your cash flow statement actually shows an inventory decrease.

Is there some accounting or something else going on?

What's actually going on with the inventories in Q4?

Why did they go up on the balance sheet and what are your plans for your inventories going forward?

Thanks, Stacy.

As you know, in any merger purchase price accounting has a lot of moving pieces.

What I would suggest on this, rather than get into the nuance of the movements one way or another, we take it as an action item to follow up with you, walk you through the details from a purchase price accounting standpoint and go into the detail as granular as you would like with respect to those.

Did actual physical inventories go up or down then?

Because the cash flow statement shows a decline.

Did they go down?

I think, Stacy, what's difficult, as Dan mentioned, is that, given purchase price accounting, there are a lot of movements.

So, what I would like to do is maybe when you and I have a call back later on today, we go through the details of that.

Fine.

And if I could just follow up really quickly, which parts of Freescale were stronger than expected and which parts of NXP were weaker?

We are not going to go to that level of granularity.

The question is completely obvious.

What RIck said is we are a single company going forward.

We are very excited about the two companies together.

In the last quarter NXP was slightly weaker against our guidance, Freescale a little bit better against their guidance at the midpoint.

But we are not going to parse it down to the individual levels because it's just apples and oranges, quite honestly.

We only had one month stub of Freescale, a full quarter of NXP.

I don't think we are going to be able to go there for you.

All right.

I guess I'm 0-for-3 then.

Thanks, guys.

Thank you.

Our next question comes from Vivek Arya of BofA Merrill Lynch.

Your line is now open.

Thank you for taking my question.

I know that you're still working out the base of cost synergies.

But just conceptually do you think there is a way to accelerate them given the demand environment is very different than when you announced the acquisition?

I think when you announced the acquisition, you mentioned $200 million of synergies in the first year and $500 million longer term, but the demand environment is very different.

So, just conceptually, is there a way to accelerate the cost synergies?

And, more importantly, given that you are not providing cost synergy on a quarterly basis what is the right way to measure NXP?

Is it an operating margin number that we should be tracking instead of a specific cost synergy?

A couple points.

I want to disaggregate the cost synergies from just driving a disciplined business as the cycle fluctuates up and down.

So, if we talk about synergies, the Company is driving hard to capture the $200 million.

Feel very confident that it will actually probably exceed that, but let's stick with the $200 million target.

On the April 28 analyst day we will provide margin guidance to the community, which shows progression over time, and it will reflect the capture of those synergies.

With respect to how we operate the business given the fluctuations up and down in the cycle and the discipline with which we do that, they are not related to the synergies.

So, accelerating the synergies because of the ups and down movements of the cycle, we're just going to run a disciplined business and position ourselves for success going forward.

I think we have appropriately aggressive targets with respect to synergy capture and we're going to stay disciplined in terms of executing to the plan we have in place.

On top of that, depending what we see from a macro environment standpoint and a specific industry perspective, we will operate and manage the business in a way to drive value for shareholders.

If I could just add one thing to that, I think if you actually look at the performance of the legacy NXP business and the legacy Freescale business, we both took actions with the environment in the previous few quarters, as we saw the pending merger.

If you look at the OpEx levels that we had through that period of time, they were really leading edge associated with it.

As we move forward, clearly we are going to invest at appropriate levels to make sure we grow the business, but we will modulate that based on the environment that we see.

So, I think the best way to describe it is, is we'll come back to you with the analyst day more on a percent basis, because again we plan on continuing to invest in growing this business and ensuring that we continue to outgrow the market going forward.

Got it.

Thanks, Rick.

Dan, very helpful.

And as my follow-up, I think the automotive part of the story is clear.

It's very interesting.

But traditionally, Rick, you had other strong secular growth opportunities, whether it was in banking cards and mobile wallet or other areas.

Can you just give us just conceptually how those opportunities look going forward, so just something beyond auto that you are excited about as you look at the rest of the year?

We talked about the combination of the two companies really positions us quite well on connected devices.

And actually if you are more complete in that, connected devices and the infrastructure to support those connected devices.

A lot of people call that the Internet of things and talk about opportunity.

You can read all over the place from 25 billion to 30 billion items by 2020, to as many as 50 billion items by 2020.

So, clearly bringing the strength of both companies together positions us extremely well to be able to participate in that high-growth market between now and 2020.

When you think about the overall semiconductor demand outside of automotive, we think that the high-end smartphone business is not going to have the same growth it has historically.

We think we are getting to levels that are not going to have the same kind of growth.

The interesting thing that we have is the deployment of the mobile wallet and smartphones is still at a relatively low level in total.

And with the implementation of Apple Pay, which I understand is going to be implemented in a few months in China, we think that the rest of the market that's supplying the market besides iPhone will have to have an equivalent product to be able to be competitive with the iPhone solutions in China.

So we're very excited about the opportunity there that's moved out over a period of time from what we would have originally anticipated, but we still see the opportunity significantly.

But even above that, what we're really trying to do to accelerate that growth is working with the transit authorities in China.

We are working with the ten largest cities in China to roll out a solution using a smartphone as really the approach for our ticketing to accelerate the boarding of the transit systems and improve the convenience while maintaining the security associated it.

So we see that as at a significant opportunity.

The position that we have with the combined microcontroller business and the ability to drive the i.MX are significant opportunities that we think we are well positioned to be able to address in the market.

And when you look at the near term, we see some sign of life with the base station market in China actually driving some near-term improvements associated with it, although the sustainability of that over an intermediate period of time is probably questionable based on the logistical approach that we have seen all the base station customers look at.

So, we see a number of growth areas in the near term that will create growth in the new NXP going forward, and are quite excited about the opportunity to participate in those, and continue to feel comfortable that we will exceed the growth of the overall semiconductor industry as we consistently have been able to deliver.

Thank you.

Thank you.

Our next question comes from Craig Hettenbach of Morgan Stanley.

Your line is now open.

Yes, thank you.

First just a question on the strength in gross margins in the quarter and outlook, if you could just talk to some of the maybe elements of mix.

And then also I know for Freescale there were initiatives to drive gross margins up with new products in manufacturing, if there is any update on that, please.

Absolutely.

In any given quarter you're going to have puts and takes and you are going to have some businesses performing stronger, others performing weaker.

As we aggregate that performance in Q4 we get the type of margins we're talking about.

What I would say, though, is that the last ten months, last year of merger integration planning and being able to get out of the box strong and having an operations team that has a standard set of metrics in place, factories are aligned to a consistent set of goals.

Technology road maps are integrated and locked in place.

We have got a number of pieces in place that allow us to nimbly manage the infrastructure based on the environment we find ourselves in to produce the results that we saw in Q4.

So, it's as much a mix as it is the way in which the teams are coming together and aggressively managing in a tough environment.

As we roll forward to Q1, again, there is going to be puts and takes.

First quarter is a combined company out of the box.

We want to be disciplined and appropriate from a guide standpoint.

But Q1 is typically a difficult quarter because annual price negotiations that we have with our customers start to get layered in in Q1, and then over the course of the year we continue to ground out the cost and efficiency of the operating assets to get the gross margin in line.

So, typically Q1 is a little bit of a headwind for us, but we are aggressively managing it and looking to mitigate those impacts as much as possible as we deliver Q1 results.

Craig, we do appreciate that you picked up on us joining the 50-plus club going forward.

We are very pleased with the accomplishment of now moving into the 50-plus category on gross margin, although we continue to believe the thing that's really important is the operating income level, which is what's going to drive the overall cash flow of the business.

But I think the important thing that we have, with the base that we've established already, of 50-plus.

And, as we've talked about, probably roughly 20% of the synergies coming in the form of cost of goods gives us a really good solid basis to be able to continue to see our gross margins expand going forward.

Got it.

Thanks for that.

And then just as follow-up, Rick, you talked about positive feedback from customers for the Combined Company.

Specifically within automotive what are you hearing just from the product portfolio and breadth?

Are there opportunities where you were strong with certain OEMs and you can pull Freescale in?

And vice versa?

I think the relationship of both companies has been quite strong, although it's different by different customers.

I think when you look at it on a combined basis we cover all of the major tier 1s associated with it, with strong relationships.

As we have met with the leadership of all of those companies, they have been quite pleased and excited about the opportunity.

We had a number of customers that actually engaged with both companies in an agreement before the close of the transaction through an improved process so that we could work together on a solution bringing the technology of legacy Freescale and legacy NXP together to be able to drive a solution, which has really been exciting for our customers.

When you actually look on the car infotainment side, where legacy NXP basically owns the audio side of the car radio market, the feedback from our customers is that if we can drive the apps processor we will bring a complete solution so them, kind of a radio in a box, that they can then work on the areas where they can work on fidelity and sound quality that's beyond just the electronics itself.

They continue to be very excited.

We had a very successful CES show where we had significant participation and a lot of excitement through the combination of the products, and actually saw the Secretary for the Department of Transportation who came to [chur] specifically the demos that we had associated with ADAS and assisted driving and the implications that it might have in making driving safer, with his concern specifically in the US but obviously for around the world.

So we think that we can play a significant role in making driving safer and more secure.

And we have had nothing but extremely positive feedback from all the customers that we have engaged with.

Great.

Thanks.

Thank you.

Our next question comes from Ambrish Srivastava of BMO Capital Markets.

Your line is now open.

Hi, thank you.

Good morning.

Rick, I had a question on the distribution and the channel inventory that had built up last quarter, which had led to the disappointment.

You had mentioned that you were going to address that.

Good to see that the levels have come down.

But what specific or mechanical actions have you taken to ensure that this kind of disruption does not occur in the future, given that now you're a much bigger company with the combined assets of Freescale?

We've definitely taken actions relative to on a legacy NXP basis where we had some of our Asia distis that were providing us information on a monthly basis instead of a weekly basis, that we have now corrected and have that information flow in on a weekly basis so we can do a much more complete and thorough analysis of the inventory levels on a more real-time basis than what we were able to do in the past.

We also made some organizational changes to be sure that we had the detailed analysis to be able to support that.

I think we have taken some of the right steps.

We have more to do as we go forward to be sure that we drive that.

But really the key is shipping a lot less in.

We reduced the shipments in to the distribution channel by 22% in the quarter on a combined basis, while the shipments out of distis was only down 5%.

So, I think we took proactive measures as we really saw that inventory grow to be able adjust that on a pretty real-time basis, although clearly we got caught in on the quarter end in Q3 where we had to take the actions in Q4 to actually get back to the sustainable level or a level we felt comfortable with.

But I think we have taken the actions.

We have taken the appropriate actions.

It's been a high priority for us in the last few months to be sure that we do that.

Dan has put some people on specifically to be sure that we're looking at it in a different fashion, a more thorough fashion.

And we have been able to work with our distribution partners to be sure that we get that information on a more consistent basis, as well.

Okay.

Very good.

And a quick follow-up, last quarter also, and I know it's a smaller piece of the business, that aftermarket in China had ballooned up a lot.

Has that normalized on a combined basis?

I'm sure it's less than 1% now but that was an area that had caused disruption.

Thank you.

I think we talked about that earlier.

If you look at that, we still have inventory levels that are higher than what we would like in the car radio aftermarket.

We made some progress in the Q4 levels, but we would anticipate not getting down to the absolute level we'd like to be at for at least another quarter.

I think we have seen the market improve somewhat, which is good, in the car radio aftermarket.

And make you didn't catch it earlier when we talked about that on last earnings call where we said a fourth to a third of the car infotainment market was in the car radio aftermarket, that was really in terms of quantity, not in terms of dollars.

When you actually take it into dollars, it's more like high single to low double-digit percent of the car infotainment market, which would put it at half that from an NXP basis -- on a combined NXP and Freescale basis at even much more reduced.

It would be roughly a fourth or so of that that level.

So, it's not really significant or material in the combination of the two companies, but the inventory level is not the level that we'd like for it to be on a consistent basis.

And we still have actions underway to get that down to the appropriate level.

Thank you, Rick, for clarifying again.

Thank you.

Our next question comes from Blayne Curtis of Barclays.

Your line is now open.

Hey, guys, thanks for taking my question.

Dan, on the interest guidance it seems flat quarterly.

I was just trying to understand the decision -- you did buy back some stock in the quarter -- just the decision between delevering or buying back stock.

And is that guidance for the year reflective of your thought of what you would do or are you leaving that for when you do it?

A couple things on that, Blayne.

First, we are straightlining the interest expense throughout the year.

We will come back an April 28, talk about long-term capital structure, target ratios, those types of things, and get a little bit more granular in terms of the puts and takes on how that profile is not only for the balance of the year but looking into subsequent years.

With respect to near-term decisions on the capital structure, look, we are going to make smart choices about how we deploy the strong cash flow profile of this Company and do smart things.

But on April 28 we will spend more time talking about what that looks like longer term.

Great.

And then I just wanted to follow up on a previous comment or a question on gross margin.

Obviously you had upside there.

What specific products or segment throws that mix that you referenced to the upside?

Then if you could just talk about -- a similar other question -- as a starting place usually the gross margin synergies happen later.

Is it accurate to think this is your starting point and you can add those synergies on top of this?

From a timing standpoint, we understand the power in the gross margin.

If we really want to invest for future growth in this business, every ounce of efficiency we drive into the operating assets, every ounce of efficiency we drive from an SG&A standpoint, allows us to invest in a way that will drive future growth.

So, we understand the importance of the bookends for the R&D line from a synergy standpoint.

And we are not wasting any time driving really hard and getting a fast start.

And I think you see some of the evidence of that in the current quarter and you will see that profile over 2016.

Rick went into detail on the businesses where we were seeing some signs of strength and certain areas that were showing some signs of weakness.

I would hesitate to go into more granular detail than what he has offered at the highest level now between the different operating segments.

Thanks, Dan.

Thank you.

Our next question comes from CJ Muse of Evercore.

Your line is now open.

Good morning.

Thank you for taking my question.

First question, Rick, in terms of your outlook for SCD -- and I know you don't want to go out beyond a quarter -- but curious if you can just talk at a high level, given the slowdown we're seeing, how union pay agreement with Apple will start to flow through, and whether or not -- the confidence you have in terms of growth for that segment this year.

CJ, thanks.

I think that the key is basically what I talked about earlier.

While we believe that Apple Pay deployment in China -- and not, by the way, just China, but I think they announced four or five countries that they are deploying Apple Pay to in a very near-term basis -- I think that's going to change the landscape for all of the China Inc.

high-end smartphones where they are going to have to have an equivalent capability to Apple Pay to be able to capture their share of the market.

So I think that's really the important facet.

But the thing I also mentioned was that we have actually taken steps to accelerate that.

We are working with the transit authorities in China in the ten largest cities actually implementing the transit ticketing capability on the smartphones, which is extremely convenient in accelerating the boarding of the mass transit systems and the ability to make it much more convenient as well as secure for the users.

We see that opportunity being one of the significant contributors to that.

We also have in that segment the microcontroller business and we can plan to continue to see strong growth there based on the design wins we have and be a significant contributor, as well.

So, it's a combination of both of those areas that we think gives us the ability to see that growth going forward and allows us to feel comfortable about the opportunity to significantly out grow the market.

That's very helpful.

If I could follow up, Dan, I know you're hesitant to talk about stand alone Freescale.

It's now one combined company.

But Freescale gross margin uplift was clearly a part of the old story and now a part of the combined story.

So, curious how we should think about the uplift there.

And what are the key milestones we should be looking at?

Thanks.

I think if we rewind the clock a year and we look at a similar quarter from a year ago and what was communicated in terms of the long-term approach Freescale is going to take to drive gross margins, I don't think anything changes there.

What I would say is use that as the starting point.

We are very confident in what we laid out a year ago.

We still see the same opportunities in front of us.

And on April 28 we will spend a little more time talking about what that means inside of the Combined Company and how we drive that gross margin profile on a go-forward basis.

CJ, we still believe that the important thing is operating income percent and not gross margin percent.

But at the same token, we finally have gotten to the point where we can join that 50-plus club and are very pleased with the opportunity to continue to move forward from where we are.

Very good.

Thank you.

Thank you.

Our next question comes from Will Stein of SunTrust.

Hi.

Thank you for squeezing me in.

I have a question about the integration and maybe the cultural aspect of it.

When I think about the two companies historically, I think there is two big differences I think of, and one is the very centralized around Austin culture that was in place at Freescale versus the much more decentralized one at NXP.

And the other is NXP's historical very clear focus on achieving 1.5 times RMS.

It's difficult for Freescale business, especially given the big microcontroller focus.

I'm wondering -- and I'm sure you'll elaborate on this at the analyst day -- but initial impressions as to how the cultural integration is working from both of those perspectives would be helpful.

Thanks, Will.

I think it's really important to understand that we still maintain a true leadership, is the only way to manage in the semiconductor business.

So you'll see the combined business be very focused on at least 1.5 times RMS on the areas that we're investing in.

and we'll clearly drive a focus on our investments to be sure that we are doubling down in those areas where we can do that and we are cutting back in the areas where we don't have that same opportunity.

So, that is one of the ultra fundamentals of the Combined Company that we believe will be important in contributing shareholder value for us.

As far as the management styles I think you have been a little kind on us.

The historic NXP management style, I would tell you, is more nomadic management style, while clearly Greg and the team were very fortunate to primarily be in Austin with a hub-and-spoke management style.

So, I think that's clearly an adjustment that we are going through.

We have seen nothing but cooperation from the Freescale managers that are joining.

I think Dan has already gotten his housing taken care of in Eindhoven.

We'll still be headquartered in the Netherlands associated with it.

But our management style requires very much of a nomadic basis.

Unfortunately, that's really a burden we put on our managers.

But we think being close to the customers and close to the employees around the world is really the best way to drive the success, and we'll expect to continue to see that going forward.

We have seen that be well received on the Freescale side.

It requires more discipline relative to communication, so that you have to schedule time for video conferences and conference calls to be able to maintain communication.

But it's an approach that we have found to have worked well so far and we see no reason it won't continue to work well going forward.

And just to add a little bit to what Rick said, if I may, we made a decision -- first of all, I am glad you are asking about culture.

Based on my prior experience, culture is one of those key elements to successful integration.

You got to get it right if you want to drive the value from the industrial logic that ultimately created what we're creating here.

We made a decision a while ago that as soon as we closed this transaction, there is no more us versus them or us and them.

It is just we.

It drives a philosophical approach to address the issue that you're raising right now.

And we have made surprisingly good progress early on in melding these two cultures and getting everybody focused on our customers' requirements and success in the marketplace.

I couldn't be happier with the cultural integration progress we're making.

But the approach we're taking, really at the core of that is a philosophical belief on the importance of blending these cultures on a go-forward basis.

I know there is unsatisfied questions out there on unpacking the results in former Freescale, former NXP, but it really is consistent with our philosophical approach and the importance we place on blending these cultures that we no longer have a them and us, literally day one.

And we drive this into our own company on a day-to-day basis.

It is we.

And that's a bit of what is driving the philosophical approach to some of those questions.

Will, did you have a follow-up you wanted to address today?

I will try an end markets question.

I am not sure if this is on or off limits.

But it looks, relative to my expectations anyway when I glued the two models together, it looks like the Q1 outlook is quite a bit stronger in automotive and the secure interface infrastructure segments.

And I'm wondering if you might comment as to whether management feels the same way and those two end market groups are doing better.

And then perhaps any detail as to product categories one layer below in terms of strengths and weaknesses.

It seems like those are the longer cycle end markets, which is encouraging, and I wonder if I have that right.

That's very observant, Will.

I think when you look at it, the automotive strength in the guidance for Q1 clearly is there.

And we've seen a real strong uptick from our customers in both legacy sides of the house associated with that.

So, it's not any one side or the other.

We see a very strong position in automotive across the board.

When you talk about the interface and the infrastructure, a significant share of that, of the outlook, comes from an improvement in the RF power business in the near term.

Now, how sustainable that is over the long term, I think we have proven that the logistics capability of our base station customers is not world-class.

But the bottom line is for the near term we see an improvement, we see requirements, and so that definitely contributes to the Q1 outlook that we laid out.

And clearly everyone knows that the smartphone market is much weaker than what it's been and continues to be reflected in our outlook, as well.

Great.

Thanks.

And congratulations.

In closing, we would like to share with you four key messages.

The integration of the two companies is on track.

We see even more opportunity on the product side than we had originally anticipated.

And our customer reaction to the combination has been enthusiastic.

NXP becomes more diversified in terms of products, customers, end markets, and geographic exposure.

The merger will substantially enhance our margin profile due to ongoing operational improvements combined with the cost synergies Finally, the cash generation capability of the Combined Company is very significant, even if the challenging environment, as we demonstrated the capability in our Q4 results, and become even more so as we move forward with the benefit from the combination.

Thank you very much for your interest and support.

Thanks, everyone.

This will end the call today.

Ladies and gentlemen, thank you for your participation on today's conference.

This concludes the call.

You may now disconnect.

Everyone have a nice day.