NXP Semiconductors N.V. (NXPI) Q3 2016 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Third Quarter 2016 Earnings Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will follow at that time. [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 is Rick Clemmer, NXP's President and CEO, and Dan Durn, our CFO. If you've not obtained a copy of our third quarter 2016 earnings press release, it can be found at our Company Web site under the Investor Relations section at nxp.com. As most of you have likely see the Qualcomm and NXP press release this morning, and we appreciate your patience and waiting for our earnings call to begin. Our earnings call today we’ll keep to our prepared remarks to the key points so we can quickly get to your question. This call is being recorded and will be available for reply from our corporate Web site. Our call today will include forward-looking statements that involve risks and uncertainties that could cause NXP's results to differ materially from management's current expectations. Please be reminded, 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, 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 Web site. I'd 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 margins due to a combination of solid execution by the business and operations teams, 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 transit or mass mobile payments, or mass transit is a perfect intersection of secure payments and high throughput mass transit; all delivered on a mobile device. And China’s six out of this ten initial largest cities are up and running with our mobile transit solutions, and eight OEMs have launched this solution. Initial activation rates are very good, and post activation top-offs are showing promising trend. 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 that was offset by roll-off of legacy MCUs. Lastly, we experienced solid demand in our mobile audio business as new products have gained solid tractions with Chinese Android handset OEMs. 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 markets will continue to be relatively soft over the intermediate term. Given the supply chain model in the base station market, we continue to have difficulties determining accurate in-market demand trend. In the Digital Networking market, we experienced flattish demand as anticipated, and believe the business has began to bottom-out. We are somewhat encouraged, as we are seeing composite trends in terms of design win, and particularly in the enterprise wireless access and switching space. Within SIS, revenue was $178 million, down 11% sequentially, and down 34% from year-ago. This was essentially in line with our inline 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 U.S. contact EMD market based on the current market and competitive dynamics that we’ve mentioned in the past. At this point in time, the trends within the e-gabbing transit and access in- market with some improvements are not sufficient to offset the decline in the banking revenue. As our fourth quarter guidance reflects, we’re guiding for further stepdown in this business. We think over the intermediate term, revenue will hover around $150 million per quarter, although Q1s are typically seasonally 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 to 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 the inventory, increasing $45 million on a sequential basis. In summary, Q3 was a solid quarter with the strong financial performance, a positive reflection on the progress towards our committed goal. We view the overall stemming market as being next. In certain end market, like auto and SBD business trends are very encouraging. However, the market trends in the SIS, RF Power, digital networking, continued to create headwinds for the overall business. We believe we found a bottom in both SIS and digital networking, the two most challenged business 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 your questions as quickly as possible, I’m going to read in 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 Web site 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 margins above the 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 $0.5 billion in share repurchases; specifically, we delivered revenue of $2.47 billion in Q3, up 4% sequentially and the 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 54 basis-points of non-GAAP operating margin expansion. On a $10 billion revenue run rate, this 540 basis-points of margin improvement, which suggests 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 $86.3 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 & 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 margin. And finally, I'd like to take a moment to discuss the status of the Standard Products divestiture. We've received all the regulatory approvals associated with the divestiture. The disentanglement process is going very well and we're on track to close the divesture in Q1 of 2017. From a financial model perspective, post the 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 band of our long-term margin ranges exiting '17. 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 on synergy capture, and we minimize the impact to stranded costs from the divestiture throughout 2017. In terms of the use of proceeds, NXP will net $2.3 billion from the divestitures. 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. And lastly, we will pay-down approximately $1 billion of the term loans due in 2020. Post redemptions, gross debt will be approximately $7.5 billion with a weighted cost of debt at 3.6%, and an annual interest expense of approximately $275 million. Putting this together with the Q4 cash balance and adjusted EBITDA, that is consistent with Q3 where we saw net leverage of 2-time]. 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] And our first question comes from the line of John Pitzer from Credit Suisse. Your line is now open.

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 looking cautiously your December quarter guidance. What would you expect channel inventory to look like exiting the December quarter?

So to be clear 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. So we’ve still continued to be around that level. To be clear, as we go forward, we’re not planning on it changing significantly, but we want to be opportunistic. There is a lot of interesting things developing in the channel market with one of our competitors and we want to be sure that we’re playing that opportunistically to have an impact from a top-line revenue growth basis.

And then, Dan, I just want to make sure I understand some of the up margin, you’re taking t about exiting 2017. I guess, first, does that include or exclude the standard product divestiture I apologize if I missed that. And just given the announcement this morning, would there be opportunity to try to sum to accelerate some of the organic synergy gains at NXP ahead of the merger? Or how should we think about that?

So, John, a couple of things. First, the guidance we gave just provide clarity, post the divestiture, how the Company will profile. It’s very consistent with what we said at the Analyst Day, and very consistent with what was said at the time we announced the divestiture of Standard Products. Exiting the year, on a run-rate, we’ll be close 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 absolutely clear on this. While we can plan for integration as a Company and strong execution post close is a function of really stay on granular detailed bottoms-up planning. It is just that planning. So there will be no change to the decisions we or Qualcomm made as independent company 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'll start to see decision makings reflecting the combination of the two entities, and economic impact associated with it.

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

Our next question comes from the line of Ross Seymore from Deutsche Bank. Your line is now open.

I guess, 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 Analyst Meeting earlier this year, with the price that Qualcomm is paying and you're accepting that price. Any framework in how you view valuation will be helpful?

I think, Ross, it's really important to realize that the pre-rumour price, this represents 34% premium. So for a transaction of this size, it's a pretty sizeable 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, and autonomous driving it, it's become more obvious to curtain 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 ad hoc solution as opposed to the areas where we had clearly identified the leadership that can drive. So, we think that's very complementary. Although, we have good connectivity platform for our current portfolio as we look out over the next few years. We’ve 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 together pretty 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's a lot of broker lap between the shareholders of both company. And there's clearly an opportunity for both shareholders that view the value creation opportunity as significant as we do for them to participate in that by actually buying Qualcomm shares.

And I guess as my follow-up. Dan and Rick, you could answer this too, if you wish. But you did a great job of running us through where the margin structure will be as we think about the next 12 months or so. From the revenue side of the equation, at that same Analyst Meeting earlier this year, you talked about 5% to 7% growth rate over-time. I realize that doesn't imply to any given single year. But how are you thinking about that as you look into 2017 as like automotive are doing better than people feared, and you're growing well on SBD. But area is like SIS and maybe the high power RF might be a little disappointed, or just disappointing versus what you might have expected in May?

My answer will probably leave you a little unsatisfied. The revenue CAGR we gave you is exactly that a CAGR over a three year widow. I think we have a portfolio of businesses. And like you point you and like Rick said in his comments, we’ve got some businesses that are performing really-really well. We've 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. And so rather than getting to an extra size with guides, one year out, what we want to do is just stick to the three year CAGR. We understand than markets we participate in. You understand the core franchises we have, the leaderships positions we have, within those respective end markets and the performance profile of those businesses. And that should give me a pretty good idea of how profile next year. But we won’t get into the extra size of guiding the year out.

I think the only thing that we could add is when you look at our outlook for Q4, the guidance that we set, that we talked about 2016 will be a transition for us. And Q4 not being down as you would typically be on a seasonal basis. It’s actually a little better than the environment. So, I think it actually portray an leading indicator relative to it. But as Dan said, we really only guiding. We’ve only established that on a three-years compounded growth rate, but it’s just not in the individual units period.

And next question comes from the line of William Stein from SunTrust. Your line is now open.

Thanks for taking my question. And then I’ll add my congratulations to the deal this morning, I’ve two question 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 will use the goal post. Where we’re today and where we will exit 2017. And at the time of the announcement, we’ve talked about this being synergy capture window. And I think with those goal post in place and the trajectory implied by those goal posts, I think that you can pretty quickly come up to what that is, rather than go out with a specific number, I think the goal post gets you where you need to be.

And the next question is about the seasonally strong growth in autos for Q4, I think seasonally that’s a down quarter, but you’re guiding up. Should we use it’s, it’s uncertainly like a content growth opportunity. Is this the initial ramp of V2X, is that meaningful part of the separation? Or is there something else going on there? And any update on other V2X design winds in general would be much appreciated.

Will, it’s broad based. So I think the key is it’s not V2X. V2X is not a significant revenue contributor in Q4 this year. There is some shipments taking place obviously on the design win that we’ve talked about. But as far as being a significant contributor into revenue, it’s not in V2X. It's pretty broad based, but really focused on MCUs, and beginning to ramp some of the design wins that had been achieved over the last few years as those begin to be realized and shipped into the customer.

Our next question comes from the line of Stacy Rasgon from Bernstein Research. Your line is now open.

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

So, Stacy I think it's -- obviously, any value is what you negotiate between two parties. And we can't lose sight of the fact that it was a 34% premium to the pre-disclosure, pre-rumour period. And when you think about a transaction of this magnitude, a 34% premium is at least as we've been advised pushing the limit associated with it. I think if we think about the future, the value of bringing the two companies together and bringing the most compelling platform in the industry going forward, it's just too significant of an opportunity to forgo. And so we think that we've gone through this with our Board and our Board feels like that this is a fair price, and a price that's reasonable for our shareholders. And 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-rumour price is a significant factor associated with it. And Peter Kelly -- Stacy, Peter has joined us too here.

Stacy, I just want to say I guess one thing. I mean, overall, I do thing this is a terrific deal. You're right in pointing out that Qualcomm shareholders are very pleased. As Rick said, the improvements in our stock price versus and unaffected price is very-very substantial. And I'm not at kind of cope or finance expert, but I think our stock will trade more on discounts to close than anything else in the coming months. But I do think this is a terrific deal.

And just to follow-up on that though. I mean, why wouldn't you guys be willing to -- put in the work over the next few years to achieve a higher stock price on your own. I mean this thing isn’t going to close for over a year anyways. What makes you think you couldn't get the stock price above a $110 on your own by the end of 2017? It seems like given the margin targets you talked about and the growth goals you talked at the Analyst Day, something that would be or should be achievable with more upside beyond that. So like why wouldn't you try to get it now rather than selling out at $110 today?

So, Stacy I think the key is we're comfortable with the performance we've laid out. We're very comfortable with the portfolio we have. The opportunity to have a more complete ubiquitous platform to be able to address the market opportunities we see, we just thought it was too significant an opportunity for go. We think that it's 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 opportunity they can participate in it through Qualcomm shares. And there's a significant cross-holding between the two companies in any case, Stacy. So, this has nothing to do with us. Not believing in what we've laid out. We still feel very comfortable associated with that. If you look at what we've traded over the last couple of years, we typically have traded at a discount to our peers associated with the industry. And so for us to be able to achieve this with very significant premium for a very large deal is something that we feel like is really as good result and one that we’re very pleased with.

And as Rick said, this is about creating a powerhouse. This is just a fantastic opportunity. So just create a powerhouse company.

Okay, thank you.

Thanks Stacy.

Operator, we’ll take one last call here this morning. We’ve got -- we want to keep this abbreviated today.

Okay. Our last question comes from line of Tore Svanberg from Stifel. Your line is now open.

Rick, you mentioned the Secure ID business is bottoming. And I think you said that for two quarters now, is expected to be down again sequentially in the double-digits for the December quarter. What are some of the milestone that we should look out for that business finally stabilizing?

That’s a really good question. I think that we shouldn’t lose sight of that that business is really the technology that gives us the ability to provide security on a broad base set of solutions. Now, in addition to that, obviously, we have product shipments that take place associated with it. And clearly, we’ve had the benefit of the stocking of the contact with bank cards in China, which we were kind of that they end up. Now, it’s going to be more of a replenishment cycle associate with it, which is not going to offer the same kind of volumes that we’ve had in the past. And with some of the competitive practices and activities, we see associated with contacts base, we’re actually being very selective in our participation associate with it. And that’s the reason why that 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's going kind of be stable. But we’ve been at this point in the past. But we did talk about the fact that there is seasonality to that business which is typically down in Q1. So even if we’re at this bottom, we could be that in any individual quarter, they could go below that. But we think we’re at that run-rate. And actually, as a percentage of the total volume, now the trends are ticketing, as well as the e-gab side becomes the larger share of the total. And we do see a number of design-wins there. As we’ve talked about in the past, that tends to be fairly lumpy. And so it’s not really a nice move to progression associated with it. But 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.

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

So the data points that support that revenue, which continues to be hard to predict, based on the supply chain that’s not easy to call. I think it's -- when you think about the fundamental assumptions, I think, we’re going to continue to see an expansion of data over wireless network. So, you should see fundamentally the ability for base stations to grow. But it's virtually impossible for us to project when that will take place. We continue to be leader in that space, so that’s very positive opportunity for us. It’s a profitable business. As we see the industry moving to more content associated with across the wireless networks, we do think there is some opportunities for the early implementation of 5G, our massive MIMO. They could play a role in increases in revenue in the upcoming quarters. But it's certainly not going to be a factor in the next few quarters. So, we expect that business to continually really hard to predict, but very nice profitability and one that we continue to be a leader in.

Fair enough. Thank you.

Thanks.

Well, everyone, thank you very much for attending our call today. We realized it was abbreviated call. But given the announcement first thing this morning, we want to let you guys get back to our new notes and things. We really appreciate all your support. And with that, we'd like to end 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.