Good Morning all. I am Matthew Prisco, Analyst from Cantor Fitzgerald covering Semiconductor & Semiconductor Equipment. Today I have the pleasure of hosting fireside chat with Jeff Palmer, Senior VP of IR for NXP. Thank you so much for joining us today.
Good Morning. Thank you Matt.
We are opening before near term. NXP has one of the head-fix over the past few years and last quarter y ou have highlighted number of positive trends across to track KPIs. Are the characteristics in these trends today that t hey make you believe we're truly on the other side of the cycle this time. And are there any surprise in trends as far through 1Q ?
We were joking at the beginning that we're not going to keep updating guidance today. Sorry. In terms of the KPIs that we can track, they have led us past the bottom in terms of the cycle. You know, direct and indirect backlog continues to builds nicely. Customer escalations are continuing as I tell you people maybe didn't lay in the right amount of material. We are seeing shipment orders increase, escalations, expedites, EDI hits from our direct Tier 1 customers continue to build. Those are all positive things. The only challenge. I hope this all sound positives, we don't see a V-shape recovery, we think it is a bit of a grind higher from here.
Perfect. Maybe digging in to that. It would be great to walk through your thoughts on recovery set of across maybe on original market. I follow up, as of last quarter essentially back at peak levels , which has gotten 1Q down. It lifts quarterly. Some of the seasonal guidance might not tell the whole story because we never had any segment of business during the whole period. Obviously, exit math is handy here, but why should we not see more cyclical snapback if that's it?
Why? I think the snapback information feel like they're out of inventory. These customers need these below what they need. What we've actually seen over the last 5 quarters is a lot of our Tier 1s all burned down inventory to appropriate levels. Our view of appropriate levels is 10-12 weeks. We track about 25 different tier ones. It's a large percentage of them are at that appropriate level. We have seen actually below, quite a bit below. We just haven't seen the snapback in terms of shipping or recovery. I think in terms of your question about auto guidance, I agree that we look at a world in which we rationalize out the best business for Q1. We have five months in which it's rationalizing off of Q1 of last year for you to see pretty decent year-on-year growth.
Now the industry, I think we're still down 10%-15% below prior peak. How should we think about the slope of this recovery in terms of cyclicality versus the bottom of the normal?
I think so. I mean, we think that the Industrial business has some really good trends behind it. One of the things we look at, as described to you, is how much channel inventory is very long tail. One of the things we look at is our end custome r backlogs in distribution. If you're a customer of ours, an Industrial customer, you buy through distribution, we can see your backlog. What we've been noticing is backlogs have been building consistently month-over-month, week-on-week. That gives us two signals. We interpreted that way. If you're a smaller mid-sized Industrial company, you continue to have backlog and you probably don't have the access inventory . Two, you're confident about the rest of your business. You don't have much backlog. We're fully optimistic on what we're seeing.
We're also seeing very good trends in order counts. There's some quite different levels in the Industrial plant business. Any other channel dynamic? Last quarter we talked about how we see one new technology cycle starting to form, which I think has about 100 times more people. This is a very different challenge to be around compared. As those conversations today seem to revolve around seasonality. I think we have a lot more visibility into what is, how to think about this dynamic since it's going to be volatile for a long time, high single digits%, double digits% maybe less than that versus what we had over the course of the last few years. I could scratch the surface, but I talked about lead times. Our target long-term lead time is 11 weeks. We've been very clear about that.
We've been above our 11-week target. I think the last time we've been global 11 weeks for 3 cyclical years. That's how tight lead times are today. All we want to do is get back to 11 weeks, and once we get there, it's safe. I love the result that many of the customer conversations apparently have been talking about. Les talked about being very aggressive with resources to the back end. Since that's something I do every day, I want to see if I can come up with more challenges that we have seen here in some serious agendas. We hear a lot of buyer memories that we help repackage memory in our whole system, in our PCs too. The topic of memory comes up in probably every customer conversation, and it's kind of two flavors.
You have certain customers who I would call very, what they consider strategic in their supply chain management. Those conversations, they're more stimulating than they have to be. But thank God for their supply and then other customers are things they may, maybe not as strategic in their supply chain, but they're annoyed that they can't get product when they want it. We're not yet at this point seeing demand destruction from those challenges.
Les, on the demand side, pricing, we've already seen a couple of uplifts of prices take place. Do we expect to see more of that as we get further into the pricing year?
Our strong book customers are still no heartburn because of the way the annual price negotiations that take place in December and into January and February. In 2026, though. That's good. We are seeing some increasing inflation in our costs. There's kind of a break point where if we can't operationally digest those increases, we do have to pass them on to our customers as we've done in the past. We will do so again if we have to announce today that we will have those increases.
Perfect. Moving on to the third piece, you said that once the economy is done, a lot of the core business can accelerate across the others. We already think that when we talk about 2027, this will be a high multiple business. You have a six business growing at about 13% over the next two years. These are also after the COVID hit. That drop rate you had mentioned is a bit, it makes a little bit of a headwind. Can you just tell us the drivers that you think are driving that growth rate for this auto business?
Yeah. We've been most focused on the core business really does tend to track production. The core business showed low single-digit range over the 2023-2027 horizon. We've really been focused on our semi and advanced drivers. Now the first part of 2025, there were headwinds that kind of depressed the semi and advanced drivers. As we moved to the second half, they did start to perform as we had expected. I think the path you pointed to is correct.
Back end of 4%-5% growth range to low double-digit %, which would mean we have to be above that rate in 2026, 2027. That's my view. It's really a content-enabled story. It's not about auto units. It's hope production grows faster than online. It's about you take the market share online, and that's delivered by higher ASPs, higher volume. You know, we've built award-winning chips and now those are going into these automotive platforms.
I agree. Maybe fabs in general suffer from a bit closure. Those two years were more than any of those players that have been working on being there. Our process is quite different from those. What I think differentiates us, I think what drives customers to us are 2 things, our IP process from the competition. You've got to think about stickiness there in the labs. Versus processor processes to further help with longevity and reliability.
The core experience right now in the auto electronics world is kind of a shift in architectures. Historically, most cars were kind of these flat point-to-point architectures with many different vendors supplying different processors and boards in the car. That was going on for many years. That did limit the car companies' ability to develop kind of a software upgrade type of philosophy like we've seen in the last couple of years. Companies wanted to build cars that sold great rather than take them off. What they wanted was build a hierarchy of processors that are capable. You've got a built-in computer in all the electronics of the car that had capabilities. It was actually those. There is S32, the entire product line is a broad portfolio of MPUs. Our processing power processors, they're very high performance. It's a breadth of products.
It's also the other hubs we can offer to the customer like modem, Ethernet, is a software-enabled digital transformation. It's really our business support to the auto helps them implement this new architecture in the cars. It's a much bigger software effort than just simply selling chips to customers. A lot of our work here, the key is the performance of the system, not just the vehicles on our side of the fence. If you think about it, on a new design car, we can guarantee performance on this front. There's a long path to that. That makes sense. Tends to be a much stickier business if you're selling a processor to a customer. They're committed to buying software for 3 or 5 or 10 or 15, 20 years. These are stuff they get swapped in very rarely.
Do you find that when you think about competition in this time, all the other guys are competing with that system a hundred times over? Or are you more getting to where it's niche solutions you're trying to do?
The way we actually think about the modern car electronics, there's kind of three big functional areas. There's the ADAS space, and in that space, we appeal to our pure fault tolerance, that we're involved in the basic layers of those boards. Then the other big space is the ADAS realm. In that area, we participate in radar kind of solutions. We don't do cameras. We don't do lidar. But there is also an opportunity for something called ADAS solution, and that's usually something called a mirror or a video. Those are tougher areas to get our product line focused in. The third area is what we kind of lead to core electronics in the car, what makes a car a car, and that's what the S32 family is really focused on.
Okay. Maybe getting into that, I think the product roadmap and design wins are really good feedback on that S32. I think it's on the path to these key partnerships. When you talk about those products, well-managed penetration and step function increases, that is the opportunity for sure for you.
The S32 family is going to grow 20%-30% CAGR, 2023-2027. The baseline on that 20 was about $1 billion in business. These were primarily our 16nm and larger type of main processors. The S25, that was just SD business grew in the teens% year-over-year. It was a little weaker in the first half, accelerated above that in the second half. The fuel injection check is coming back very clearly. The design win traction for the S32K5 family of products is very good.
I think we'll be in production sometime in 2026 or 2027. That's still a little ways away. The S32K5, which is the industry's first 16-nm logic microcontroller family, a solid microcontroller family. We just released sampling to customers. Traction's been very, very good. But again, it is a design win cycle. It's not based on Intel's pretax cash. I think Industrial has already historically been more difficult to see because it is more order driven. But even our 18F gives us some additional visibility into that.
Yeah. Maybe let's start with what drives the customer to come to your door. People problems that you're focused on and how important it is to think about the architecture that assists in the first set of use cases or to speak more about this custom
er. Sure. In the Industrial IoT business, as Bob said earlier, probably over 50% of the products are processor-based. In Industrial IoT specifically, we brought out one microcontroller family, the MCX microcontroller family, the i.MX RT family, which is kind of a hybrid microcontroller/microprocessor family. We have the i.MX application processor, which is an industry-leading Industrial application processor. When our teams go into this Industrial IoT process, they always think of the processor first. If I can win that, then you as a customer are able to innovate and write software on that platform.
Once we've imported the processor, we pull along PMICs because these products are built to be devices that manage the physical world. They can be either built to power other things like connected vehicle security and other analog technologies. You really do build reference designs for customers. It's a long tail business that depends on thousands of customers that are very, very smart in different markets, but they're not really smart in the marketing machines connected to over 700,000 designs. We make a lot of custom development kits that say, "Here, we'll take that reference design problem off your shoulders." Some of the companies pick up the reference design as, I say this, some blank product, but that's how many we've brought to them. Getting to finish off this product group, product group resource.
What recent acquisitions and how those potentially allow more further differentiation that bodes well for the future?
Sure. There were 3 acquisitions last year. They all happened very quickly, and I think some folks misinterpreted that maybe we were changing our M&A strategy and throwing a lot of deals. I think they just all happened in a short period of time. Starting first with an automotive, TTTech Auto is a software company we acquired. Key partner, they were about 1,000 very experienced software engineers in the automotive world focused on functional safety and security. We really wanted to use that capability to complement our S32 platform, because it's really around, as I said at the beginning of the conversation today, this DPF is much more software-oriented.
Having that capability in our house and being able to engage with our customer software teams is key to being successful. That's why we bought TTTech Auto. They also have a product that's called MotionWise, which is a middleware product that sits above the operating system, but below the application layer of the cloud. It's early days there. It'll take a number of years to really kind of quantify that into where customers are excited about it. TTTech Auto, very strategic behind the level of that company. The second one in automotive is a company called Aviva Links. Aviva Links is a small startup in Utah that delivers a high-speed asynchronous serial technology.
Think about ADAS, multiple modalities, cameras, lidar, radar, all generating a lot of data that they need to fuse back to the central processor, but they don't need the same amount of data back in the process to the edge node. Kind of asynchronous data structure, and that's what this, Aviva Links product does. We acquired the company very much to complement our existing customer set. There is a great synergy there. It's hard to put a time frame on it. Revenue probably not till at least 2028. Lastly, in Industrial IoT space, we acquired a company called Kinara. Kinara is a small startup doing neural process engines for running large models at the edge, at the inference power at the edge. We've been working with them.
A lot of these products just slave off the central processor. That's been interesting. It's really interesting engaging with customers. Customers are coming to us with very innovative creative ideas how they want to use this technology. It's really about learning at the edge is learning actually inference at the edge. A lot of the customers specifically want to do that is they don't want to go home to the cloud and put that data in the cloud. It's way slower than what I'm talking about. They also want higher security, higher availability. Early engagements are very, very good. Like a lot of these Industrial things, time to revenues probably at least a year or two away .
Move to the the operating leverage side, you guys went through this fundamental transition over the past five, 10 years resulting in meaningful results in things like operating margins, which rank roughly 5 points above, versus peers in large quadrants. Can you walk us through what has changed from a cost sense, sustainability of that going forward, and any changes to come we see on that?
The biggest thing that changed kind of the financial structure of the company occurred over the last decade, where when I started with the company almost a little over a decade ago, our mix fixed variable cost structure was we were about 70% fixed cost and 30% variable. It was very IT-like, right? Over the last decade, we flipped that 180 degrees. We are currently at 70% variable cost and 30% fixed.
That 70/30 mix will probably be 80/20 over the next three years as we rationalize our legacy image factories. We're moving forward with a very positive outlook. Question about sustainability. We believe in sustainable model having been shown differently over the last cycle where our peak to trough was much less than that of our peers. You know, we did kind of pick our utilization factors really down. We're able to maintain utilization at reasonable levels. In terms of the CEO, he's been with the company now 11 years. The strategy you see not at NXP [audio distortion] , he's been part of that. He was one of Kurt's direct reports at [audio distortion] when he was there. I don't think you should expect a great deal. I don't think there's any change in the financial model because of this.
As we contemplate the recovery from the upcycle, you talked about revenue growth dropping based on what cycles 1-2. Is that still the right model to use today? You know, instead when you look at the revenue per design by customers, we should be thinking about getting it towards the higher end of the target 57%-63% range .
So yes, the $1 billion in revenue on a per unit basis drives gross margin expansion. That rule of thumb contemplates revenue growth, the plant utilization and safety factors as kind of all together like that is within the parentheses. In terms of how to get it towards the high end, well each one of our end markets has a range for revenue growth. If you want to drive to higher end result, you have to go to higher end revenue. Very simple.
The exhibits are free to look at and reference. The numbers that show the timing beyond the target model came to us with the business case. Latest thoughts on progress versus plans and held back to the ground due to the timing of the subsequent test results from the exposure in June.
TSMC joint venture is going very well, ahead of schedule. For those who maybe are not aware of the TSMC joint venture they've developed with Vanguard in Singapore, where they're looking at a two-phase, $3 billion fab ready to be transplanted to Singapore. First phase is already the facility shells are built, each one is ready. There's a load of equipment, so progress is going very, very well.
What we really want to highlight is how appreciative we are of TSMC's network in this. You know, TSMC owns 30% of the company. It's an incredible visible hand in this JV, if you will. Because of that, the fact that we've built the same process project sites to effectuate this and TSMC's network, we are actually licensing TSMC's process and tools in our lab during. It should be very productive site for when we want to buy from TSMC. In terms of the investment, our original cost of investment is $2.8 billion. We're about 50% through that investment. The other 50% will go out around 2026-2027 is the current plan. I think you had a question, wanted to talk about the equity kind of best case play into that.
As you notice, we will be at 40% on our balance sheet. There's two ways to get it better than one. We're going to access lower cost or required rate. That will flow through our COGS on the P&L and that is what gets you the 200 basis points on the gross margin expansion. Below the EBITDA line, we have an entry called equity method best case. This is where we would recognize a disproportionate share of the losses as well as profi ts.
Of course, this is encouraged by the founder. When we originally announced this JV, we thought that those losses would have amounted to about $200 million altogether between 2024 and 2027. In 2025 plus $40 million. This year, they'll be about $29 million total. When we look out into 2027, I actually think the losses will only amount to about $100 million. That's $75 million below what we originally thought. You put that all together, it's $200 million in startup losses, about $125 million.
It just doesn't remain a question about whether TSMC's experience will help us avoid the hassle in order to take it off my mind.
We have other chips in the general plan. That was our best estimate at that time before shovels hit the ground. As we look to other projects, some of our other infrastructure partners too, that we've got about $200 million as a placeholder. I hear we're moving through it nicely with very good progress.
Can I just one more about that 200 basis points of EPS expansion? Really good time to get it all worked into that.
Well, the M13 blocks to get that drop are very good because while we hold 3% of it, the other 60% is a commercial foundry who is there. There's $100 million as our success metric. We don't want to dilute the value. Our current plan of record is the same. The factory will be up and online in 2028. We will receive 2028. We only close to 2028 because I think we have the 200 basis point. Yes. Yeah. If you put it all together, if we continue to execute to our long-term revenue growth projected out to 2027, we should get roughly $15 billion plus price in 2027.
Given our rule of thumb of $1 billion, 100 basis points, that looks like it'd be about 60% gross margin so in 2027. Once the fab is up and running, it'll get down to 200 basis points and done. On the OpEx side, it has to be very clear about the focused management business that's in 23% of the cycle. Revenue growth theoretically is about piece of the total pie over these next couple of years, intensity versus scale trajectory. How should we be thinking about return on this from a potential lender perspective? Yeah, so the model doesn't change. While still we think 60% is the right amount to invest, 7% ROIC is correct. Yeah, a little bit of leverage on G&A.
Yes, I understand the question. Okay, if we're growing above our target rates, should we get lower multiples and harder paying performers? Possibly, but we think because we will get the higher spend people, but the model is not changing from 16%-17%. It's at best 20%. Look, that's really kind of it. I mean, if we really can drive above trend volume growth, do we hire enough people at a 16% high rating? I don't know.
So, China historically I believe NXP is exposed here. Look, I misunderstood and hopefully I did not intimate a bit. Yeah, I counted three different changes. We had quarter basis, 25%, 17% revenue is from China . Although the transaction structure should be absolutely economically sensible, but thinking big picture, the shareholder should minimize stress exposure and source risk as much as possible. How do you view your position in the chain as a more evidence-based, more data-defensible portfolio that reduces risk over time and over time perhaps [audio distortion] ?
From our perspective, China is a strategic partner. It's very important to us in multiple ways, not only industry health but in returns to our investors. We are obviously engaged. In terms of competitive dynamics in China, reality is we'll continue to compete with our Western peers in China. You know, I would paraphrase what the large electric car companies in China have said is if you can innovate at our rate, stay on our design cycles with these things, give us value, you will always have a place here in our supply chain. You'll always win awards. It's if you fall behind or you don't innovate like we think you should, we'll choose another vendor. We don't really see today local players doing the same type of progress that we do.
Do you think there's an advantage to being the first mover? I think it's valuable to us.
I mean, it's nice. At the end of the day, in the Chinese market, there's very much an innovation game. If you come through with good products and if you can keep up with this kind of development cycles with Chinese consumers, I mean, that's what matters. Whether you're a [Dutch master or whoever it is.
This quarter we reiterated long-term financial impact, which just reminds what Mike had mentioned earlier, 15.5%-27% EBITDA to business impact.
Quite popular with individual end markets, trucking participant and the product. But I think the same transaction structure we've had has basically stayed the same going back to 2024. By the way, it doesn't partner specifically with any of our peers.
I think strategically as far as focus, you've got a business, especially in automotive and Industrial, which is over 80% of the business, is very design-driven cycles. It has more and more software and more and more physical size items or software embedded. It's that design ramps and constructions and volume over volume over volume over each year. There's no change to our credit ratings. Automotive, we think we're 9%-12% on a three-year tenor. Industrial, I would say 8%-12%. Mobile, it's 0%-4% for the year. I think our comment for business class is flattish.
Depending on what quarter [audio distortion] drives the total in the 6%-10% range. Just one other point, we had 220 members with over 2,000 seats at a busy conference season for you. Across all the conversations, do you think that the street is underappreciating the portfolio of products that you offer just overall? I mean, we have kind of a simple thesis that we offer, and that is we believe we can grow in the highest single digits over a number of years. We think we can drive gross margins, take that to more like the 16% range over years and over years, which will allow very robust free cash flow, which we return to our investors. We think that results in our EPS doubling between 2020 through 2023.
Thank you for participating.
We greatly appreciate it. Thanks.