恩智浦 (NXPI) 2016 Q3 法說會逐字稿

Good day, ladies and gentlemen. Welcome to the third-quarter 2016 earnings call.

(Operator Instructions)

As a reminder, this conference is being recorded. I would now like to introduce your host for today's conference, Mr. Jeff Palmer, Vice President of Investor Relations. Sir, you may begin.

Great. Thank you, Skyler, and good morning to everyone. Welcome to the NXP Semiconductors third-quarter 2016 earnings call. With me on the call today are Rick Clemmer, NXP's President and CEO, and Dan Durn, our CFO.

If you have not obtained a copy of our third-quarter 2016 earnings press release, it can be found at our Company website under the Investor Relations section at NXP.com. As most of you have likely seen the Qualcomm and NXP press release this morning and we appreciate your patience in waiting for our earnings call to begin. Our earnings call today, we will keep to our prepared remarks, to the key points so we can quickly get your questions. This call is being recorded and will be available for replay from our corporate website.

Our call today will include forward-looking statements that involve risks, uncertainties that could cause NXP's results to differ materially from management's current expectations. Please be reminded that NXP undertakes to obligations to revise or update publicly any forward-looking statements. For a full disclosure on forward-looking statements, please refer to our press release.

Additionally, during the call today, we will refer to non-GAAP financial measures. Pursuant to Regulation G, NXP has provided reconciliations of the non-GAAP financial measures to the most directly comparable GAAP measures in our third-quarter 2016 press release, which will be furnished to the SEC on Form 6-K and is available on the NXP website. I would like to now turn the call over to Rick.

Thanks, Jeff, and welcome everyone to our earnings call today. As Jeff mentioned, we're very excited about the transaction we announced this morning. In lieu of time, we want to provide a summary of our Q3 results, and provide you with guidance for Q4.

We will keep our comments brief, but we're prepared to address any questions you may have concerning the quarterly performance throughout the day. NXP finished Q3 with very good performance. Revenue was up just over 4% sequentially, with all business lines delivering results in line with our guidance.

We drove strong non-GAAP operating margin, due to a combination of solid execution by the business and operations team, which drove better-than-planned non-GAAP gross margin, when combined with strong operating expense control. Taken together, this resulted in very strong non-GAAP free cash flow.

Looking at the specifics, revenue in Q3 was $2.47 billion an increase of just over 4% versus the prior quarter, and up 62% versus the year-ago period. Looking at the HPMS segment, revenue was $2.1 billion, an increase of just over 4% from the prior quarter, and up 80% from Q3 2015.

From an operating segment perspective, the results are as follows: Automotive revenue was $853 million, down 1% quarter on quarter, but up 177% from the year-ago period. In terms of product line trends, auto MCU, advanced analog and sensors were all slightly better than planned, with infotainment down modestly.

In secure connected devices, revenue was $592 million, up 15% sequentially, and up 87% year on year. With our mobile transaction group, we experienced strong seasonal improvements as a result of both our largest smartphone customer, as well as good traction on new models with Korean and Chinese OEMs. Progress with deploying our mobile mass transit solution in China is going very well.

Mobile payments for mass transit, is the perfect intersection of secure payments and high throughput mass transit, all delivered on the mobile device. In China, 6 out of the 10 initial largest cities are up and running with our mobile transit solution, and eight OEMs have launched the solution. Initial activation rates are very good, and post activation top-offs are showing promising trends.

In the MCU group, revenue was up sequentially, as we saw very good demand for 32-bit ARM-based MCUs and solid demand for our i.MX apps processors, which was offset by the roll off of legacy MCUs. Lastly, we experienced solid demand in our mobile audio business, as new products have gained solid traction with Chinese androids and [OEM]s.

Within SI&I our interface and communications infrastructure group, revenue was $476 million, up 8% sequentially and up 76% year on year. In the interface group, demand was strong and slightly ahead of plan due to the seasonal handset trends, similar to what we saw in the mobile transactions group.

In the RF power group, revenue declined sequentially, as anticipated. At this stage, we believe the wireless base station market will continue to be relatively soft over the intermediate term. Given the supply chain model in the base station market, we continue to have difficulty determining accurate end-market demand trends.

In the digital networking market, we experienced flattish demand as anticipated, and believe the business has begun to bottom out. We are somewhat encouraged as we're seeing some positive trends in terms of design wins, and particularly in the enterprise wireless access and switching space.

Within SIS, revenue was $178 million, down 11% sequentially and down 34% from a year ago. This was essentially in line with our expectations at the beginning of the quarter. We do not see growth in this business in the near term, as China banking continues to be weak, and there is no incremental benefit to NXP from the US contact EMV market based on the current market and competitive dynamics that we've mentioned in the past.

At this point in time trends within the eGov and transit access end-markets, with some improvement, are not sufficient to offset the decline in the banking revenue. As our fourth-quarter guidance reflects, we're guiding for further step down in this business. We think over the intermediate term, revenue will hover around $150 million per quarter, although Q1s are typically seasonably weak, and our Q1 could be this time.

Turning now to the standard products segment, revenue was $320 million, slightly better than our expectations, reflecting an increase of 6% from the prior quarter, and down 2% from the year-ago period. Turning to our distribution channel performance, the total months of inventory in the distribution channel held steady at 2.5, with absolute dollars of inventory increasing $45 million on a sequential basis.

In summary, Q3 was a solid quarter, with a strong financial performance, a positive reflection on the progress towards our committed goals. We view the overall semi market as being [mixed]. In certain end-markets like auto and STD, business trends are very encouraging. However, the market trends in SIS, RF power and digital networking continue to create headwinds for the overall business.

We believe we found a bottom in both SIS and digital networking, the two most challenged businesses in our portfolio. Now I'd like to pass the call to Dan for a review of our financial performance. Dan?

Thanks, Rick, and good morning to everyone on today's call. To get to your questions as quickly as possible, I'm going to read an abbreviated version of my script today, hitting on what we believe are the key points. We will post the complete script on the IR website, after the call.

We delivered strong financial performance in Q3, with key highlights being: we delivered revenue that was above the midpoint of guidance. Our strong operational execution drove non-GAAP gross margin above plan. We tightly controlled our operating expenses, resulting in better fall through and stronger non-GAAP operating margin.

We generated excellent cash flow in the quarter, and deployed over a $0.5 billion in share repurchases. Specifically, we delivered revenue of $2.47 billion in Q3, up 4% sequentially, and non-GAAP gross margin toward the high-end of our guidance at 50.5%. Total NXP non-GAAP operating margin in Q3 was at the high end of our guidance, at 28%, which is up 240 basis points sequentially, and up 470 basis points in the last two quarters alone. This strong margin improvement demonstrates great progress in driving synergy capture well ahead of plan.

As we have said in the past, the best way to measure our success in capturing merger synergies is to look at the progression of our non-GAAP operating margin. Since the merger closed, we have successfully driven 540 basis points of non-GAAP operating margin expansion. On a $10 billion revenue run rate, this 540 basis points of margin improvement would suggest that we have already exceeded the $500 million synergy run rate target within the first three quarters post close, and more than a full year ahead of the schedule communicated at the time we announced the merger.

In terms of capital allocation, during the quarter we repurchased 6.5 million shares, at a cost of approximately $555 million, or $86.03 per share. This brings our total year-to-date share repurchases to just over $1.2 billion, or 14.9 million shares, at an average price of $81.62 per share.

I would now like to provide our outlook for the fourth quarter. We currently anticipate Q4 revenue will be in the range of $2.4 billion to $2.5 billion. At the midpoint, we expect revenue to be about $2.44 billion in Q4.

We expect the following trends in the business during that quarter: Auto is expected to be flat, which is well ahead of normal seasonality, and much better than Q4 from the year-ago period. Secure connected devices is expected to be down modestly, in the low single-digit range.

Secure interface and infrastructure is expected to be down modestly, in the low single-digit range. Secure identification solutions is expected to be down in the mid-teens percentage range sequentially. Standard products is expected to be flat sequentially.

We anticipate revenue from manufacturing, corporate, and other to be approximately $52 million. At the midpoint we expect non-GAAP gross margin to be 50.7%, and non-GAAP operating margin to be 28.3%. Lastly, our Q4 guidance contemplates about $12 million of IP license revenue. It is unclear how the pending acquisition will impact our IP revenue pipeline going forward.

Finally, I'd like to take a moment to discuss the status of the standard of new products divestiture. We have received all regulatory approvals associated with the divestiture. The disentanglement process is going very well, and we are on track to close the divestiture in Q1 of 2017.

From a financial model perspective post divestiture, NXP will drive top-line growth in the range of 5% to 7% CAGR over the 2016 to 2019 timeframe. Post divestiture, NXP will have a superior profit margin profile, with our long-term non-GAAP gross margin in the range of 53% to 57%. We will tightly control our non-GAAP OpEx spend envelope into a range of 14% to 16% for R&D and 6% to 8% for SG&A. Taken together, we anticipate our long-term non-GAAP operating margin to be in the range of 31% to 34% for NXP.

From a timing perspective, as we discussed in our Analyst Day earlier this year, we believe we can enter the lower bound of our long-term margin ranges exiting 2017. This means total Company non-GAAP gross margin should be about 53%, and non-GAAP operating margin should be about 31% as we exit 2017. To be clear, this is an exit rate, not a full-year 2017 number. Our long-term margin progression guidance assumes we continue strong execution of synergy capture, and we minimize the impact of stranded costs from the divestiture throughout 2017.

In terms of the use of proceeds, NXP will net $2.3 billion from the divestiture. We will use the proceeds to reduce our gross debt, and achieve our 2 times net leverage target. We plan to redeem three tranches of debt.

First, we will redeem the $390 million term loan, due in 2017. Second, we will redeem the $500 million, 5.75% senior notes, due in 2021. Lastly, we will pay down approximately $1 billion of the term loans due in 2020.

Post the redemptions, gross debt will be approximately $7.5 billion, with a weighted cost of debt of 3.6%, and an annual interest expense of approximately $275 million. Putting this together with Q4 cash balance and adjusted EBITDA that is consistent with Q3 will result in net leverage of 2 times. The ultimate amount of pay down of the 2020 term loans may vary up or down, depending on what is required to achieve the 2 times net leverage target.

Lastly, we anticipate that our cash taxes in 2017 will be about $30 million to $35 million per quarter. With that, I would now like to turn the call back to the operator for your questions. Operator?

(Operator Instructions)

John Pitzer, Credit Suisse.

Rick and Dan, congratulations on the announcement this morning. Rick, I just want to go back to the channel inventory. It looks like it was up sequentially in the September quarter. What do you think drove that, and as you look and contemplate your December quarter guidance, what would you expect channel inventory to look like exiting the December quarter?

To be fair, John, it was up, I think it was $34 million. So it was up in terms of dollar level but it was still at 2.5 months of inventory. It still continued to be around that level. To be fair, as we go forward, we're not planning on it changing significantly, but we want to be opportunistic. There's a lot of interesting things developing in the channel market with one of our competitors, and we want to be sure we're playing that opportunistically, to have an impact from a top line revenue growth basis.

That's helpful. And then Dan, just want to make sure understand some of the op margin targets you talked about exiting 2017. First, does that include or exclude the standard products divestiture? I apologize if I missed that. And just given the announcement this morning, would there be opportunity to try to accelerate some of the organic synergy gains at NXP ahead of the merger, or how should we think about that?

John, a couple of things. First, the guidance we gave is just providing clarity post the divestiture, how the Company will profile. It is very consistent with what was said at the analyst day, very consistent with what was said at the time we announced the divestiture of standard products. Exiting the year on the run rate basis, we'll be close to the low-end of our margin guidelines. It will not be a full-year 2017 number.

In terms of pre-close synergy capture opportunities, we have to be absolutely clear on this. While we can plan for integration as a Company and strong execution post close is a function of really sound granular detailed bottoms-up planning, it is just that, planning.

So there will be no change to the decisions we or Qualcomm make as independent companies in the deal pendency period, and we will continue to execute against the plan we just communicated. Post close of the Qualcomm transaction, that is when you will start to see decision making's reflecting the combination of the two entities, and the economic impact associated with it.

Maybe just one thing I'd like to point out, John, we talked about that our Q4 Outlook includes $12 million of intellectual property revenue, and there could be in impact from the decision that we announced this morning associated with that. So we want to be clear that is included in our guidance, and we have to be sure that we fully understand that as we better understand the implications of the announcement today.

That's helpful, thanks.

Ross Seymore, Deutsche Bank.

The first question is on the deal with Qualcomm. How, in your perspective, either Dan or Rick, do you reconcile the earnings power that the Company described at the analyst meeting earlier this year, with the price that Qualcomm is paying and you are accepting that price. Any framework on how you view valuation would be helpful.

I think Ross it is important to realize that pre-rumor price, this represents a 34% premium. So for a transaction of this size, it's a pretty sizable premium. That being said, as we looked at the opportunity that we have on connected devices, we've been talking about this, ultimately we needed to have a better connectivity portfolio, to be able to drive the leadership that we wanted to be able to achieve.

Specifically in autonomous driving. It has become more obvious to Kurt and I over the last few quarters, that we needed increased computing horsepower to be able to do machine learning, and really be able to take advantage of the complete ADOT solution as opposed to the areas where we had clearly identified leadership and can drive. We think that is very complementary.

Although we have a good connectivity platform for our current portfolio, as we looked out at over the next few years, we clearly had to expand our connectivity capability, to be in the leadership position we wanted to on the Internet of Things, and as we focus on secure connections for the smarter world. The combination of this brings it together very nicely.

Our Board went through this and approved this, based on their view associated with the price. I think the other thing that we shouldn't lose sight of, is there is a lot of overlap between the shareholders of both companies, and there is clearly an opportunity for both shareholders that view the value creation opportunity as significantly as we do, for them to participate in that by actually buying Qualcomm shares.

Thanks for that. As my follow-up, Dan and Rick, you can answer this too if you wish, but you did a great job of running us through where margin structure will be as we think about the next 12 months or so. On the revenue side of the equation, at the same analyst meeting earlier this year, you talked about a 5% to 7% growth rate over time.

I realized that doesn't apply to any given single year, but how are you thinking about that as you look into 2017, as areas like automotive are doing better than people feared, and you are growing well in STD but areas like SIS and maybe the high power RF might be a little disappointing, versus what you might have expected in May?

My answer will probably leave your little unsatisfied. The revenue CAGR we gave you is exactly that, a CAGR over a three-year window. I think we have a portfolio of businesses, and like you point out and like Rick said in his comments, we have got some businesses that are performing really well. We have got some businesses that are performing in line, and then we've got a couple of businesses that are living in a difficult neighborhood right now.

Rather than get into an exercise which guides one year out, what we want to do is stick to the three-year CAGR. You understand the end markets we participate in, you understand the core franchises we have, the leadership positions we have within those respective end markets, and the performance profile of those businesses, and that should give you a pretty good idea of how things will profile next year. But we won't not get into the exercise of guiding a year out.

I think the only thing we could add is, when you look at our outlook for Q4, the guidance that we set, we have talked about 2016 will be a transition year for us. And Q4, not being down as it would typically be on a seasonal basis, is actually a little better than the environment. I think it actually portrays a leading indicator relative to it, but as Dan said, we're really only guiding, we have only established that on a three-year compounded growth rate basis, and not an individual year period.

Thanks.

William Stein, SunTrust.

I'll add my congratulations to the deal this morning. I have two questions if I can. First, Dan you highlighted that the Company has already achieved its $500 million cost savings run rate, quite a bit earlier than expected. I wonder how much you see as left, now that you've achieved that? Do you think there is more to go as the Company progresses?

I think I would use the goalposts of where we are today, and where we will exit 2017. And at the time of the announcement, we talked about this being a synergy capture window. I think with those goalposts in place, and the trajectory implied by those goalposts, I think you can pretty quickly come up to what that is. Rather than go out with a specific number, I think the goalposts get you where you need to be.

Fair enough. The next question is about the seasonally strong growth in autos for Q4, I think seasonally that is a down quarter, but you are guiding up. Should we view this, it sounds certainly like a content growth opportunity. Is this the initial ramp of V2X, is that meaningful part of the separation, or is something going on there? And any update on other V2X design wins in general would be much appreciated. Thank you.

Will, it is broad-based. I think the key is it is not V2X; V2X it is not a significant revenues contributor in Q4 this year. There is some shipments taking place obviously on the design win we've talked about.

But as far as being a significant contributor to revenue, it is not in V2X. It is pretty broad-based, but really focused on the MCUs and beginning to ramp some of the design wins that have been achieved over the last few years, as those begin to be realized and shipped into the customer.

Stacy Rasgon, Bernstein Research.

I wanted to go back to the deal itself. I understand, I think, the need to achieve a better connectivity portfolio to achieve your goals. But if that is the case, why is selling for $110 to somebody else absolutely the best way to get to that connectivity? If I just look at the stocks right now, in the pre-market Qualcomm's up something like 4% or more. You are up barely 2%, which suggests that right now shareholders of Qualcomm are happier with the deal then shareholders of NXP. Why is this the best way to get what you need, in order to achieve your growth goals?

Stacy, I think, it's obviously any value is what you negotiate between two parties. We can't lose side of the fact that it was a 34% premium to the pre-disclosure, pre-rumor periods. When you think about a transaction of this magnitude, a 34% premium is, at least as we have been advised, pushing the limit associated with it.

I think as we think about the future, the value of bringing the two companies together and bringing the most compelling platform in the industry going forward, is just too significant of an opportunity to forego. We think who have gone through this with our board, and our board feels like this is a fair price, and a price that is reasonable for our shareholders.

Our shareholders frankly have the ability, that if they see the opportunity as you do, or it sounds like you do, and we do, they can participate by buying Qualcomm shares associated with it. So we think it does represent a fair value.

Clearly, being at the 34% premium to the pre-rumor price is a significant factor associated with it. Stacy, Peter Kelly's joined us too here.

Stacy, I just want to say one thing. Overall I do think this is a terrific deal. You are right in pointing out that Qualcomm shareholders are very pleased.

As Rick said, the improvement in our stock price versus the unaffected price has been very substantial part. I am not a corporate finance expert, but I think our stock will trade more on account of discounts to close than anything else in the coming months. But I do think this is a terrific deal.

I guess to follow up on that, though, why wouldn't you be willing to put in the work over the next year to achieve a higher stock price on your own? And this thing isn't going to close for over a year anyways.

What makes you think you couldn't get a stock price above $110 on your own by the end of 2017? It seems like, given the margin target you talked about and the growth goals that you talked but at the analyst day, something that would be or should be achievable, with more upside beyond that. So why wouldn't you try to get it now rather than selling out at $110 today?

Stacy, I think the key is, we're comfortable with the performance we have laid out. We're very comfortable with the portfolio we half. The opportunity to have a more complete, ubiquitous platform, to be able to address the market opportunities we see, we just thought was too significant an opportunity to forego.

We think it is extremely compelling. We think that our shareholders have the ability to achieve a reasonable value out of this transaction, and again, if they believe as strongly as we do in the opportunities, they can participate in it through Qualcomm shares. And there is a significant cross-holding between the two companies in any case, Stacy.

This has nothing to do with us not believing in what we have laid out. We still feel very comfortable associated with that. If you look at where we have traded over the last couple of years, we typically have traded at a discount to our peers, associated with the industry. So for us to be able to achieve this with a very significant premium for a very large deal is something that we feel like is really a good result, and one that we are very pleased with.

As Rick said, this is about creating a powerhouse. This is a fantastic opportunity to create a powerhouse company.

Okay, thank you.

Operator we will take one last call here this morning. We want to keep this abbreviated today.

Tore Svanberg, Stifel.

Rick, you mentioned the secure ID business is bottoming, and I think you've said for a few quarters you expect it to be down again sequentially in the double digits for the December quarter. What are some of the milestones that we should look out for that business plan stabilizing?

That is a really good question. I think we shouldn't lose sight of, that business is really the technology, that gives us the ability to provide security on a broad-based set of solutions. In addition to that, obviously a product shipments that take place associated with it.

And clearly, we've had the benefit of the stocking of the contact-less bank cards in China, which we were at the end of. Now, it's going to be more of a replenishment cycle associated with it, which is not going to offer the same volumes that we've had in the past. With some of the competitive practices and activities we see associate with contact base, we're actually being very selective in our participation associated with it, and that is the reason why the business is not performing as we would have liked for it to, several years ago.

We're down to a point where we think it will be stable. We've been disappointed in the past. We did talk about the fact that there is a seasonality to that business, which is typically down in Q1. So even if we're at this bottom, it be that in any individual quarter. It could go below that. But we think we're at that run rate.

And actually as a percentage of the total volume, now the trains have ticketing, as well as the eco side, becomes a larger share of the total, and we do see a number of design wins there. As we have talked about in the past, that tends to be fairly lumpy, so it's not really a nice smooth progression associated with it. We do feel good about the business, and again the key is trying to drive the security technology on a broad base across many applications for the total Company. Especially when you begin to think about it on a combined basis.

Thank you for that, and as my follow-up, you mentioned the wireless base station market seems to still be soft and probably will remain soft. What are some of the data points to support that, and is there any visibility as to when that market potentially starts growing again?

The data points to support that are revenue, which continues to be hard to predict, based on the supply chain that is not easy to call. I think, when you think about the fundamental assumptions, I think we're going to continue to see an expansion of data over wireless networks. So you should see fundamentally the ability for base stations to grow. But it is virtually impossible for us to project when that will take place.

We continue to be a leader in that space, so it's a very positive opportunity for us. It is a profitable business. As we see the industry moving to more content associated with -- across the wireless networks, we do think there's some opportunities for the early implementation of 5G, or massive MIMO that could play a role in increases in revenue in the upcoming quarters.

It is certainly not going to be a factor in the next few quarters. We expect that business to continue, it will be really hard to predict, but very nice profitability, and one that we continue to be a leader in.

Fair enough, thank you.

Everyone, thank you very much for attending our call today. We do realize it was an abbreviated call, but given the announcement the first thing this morning, we wanted to let you get back to writing your notes and things. We really appreciate all your support. With that, we would like to and the call today. Thank you very much.

Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program. You may now disconnect. Everyone, have a great day.