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. 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' Q3 2016 earnings call. With me on the call today is Rick Klemmer, NXP's President and CEO and Dan Durn, our CFO. If you've not obtained a copy of our Q3 20 sixteen's earnings press release, it can be found at our company website under the Investor Relations section at nxp.com.
As most of you've 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 that we can quickly get to 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, 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 Q3 2016 press release, which will be furnished to the SEC on Form 6 ks and is available on the NSP website. I'd like to now turn the call over to Rick. Rick?
Thanks, Jeff, and welcome, everyone, to our earnings call today. As Jeff mentioned, we are 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 are prepared to address any questions you may have concerning the quarterly performance throughout the day. NXT 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 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 $2,470,000,000 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 $2,100,000,000 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 $853,000,000 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 $592,000,000 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 for mass mobile payments, excuse me, 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 8 OEMs have launched this 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 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 traction with Chinese Android handset OEM. Within SI and I, our interface and communications infrastructure group, revenue was $476,000,000 excuse me, revenue was $476,000,000 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 space 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 are seeing some positive trends in terms of design wins and particularly in the enterprise wireless access and switching space. Within SIS, revenue was $178,000,000 down 11 percent 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 U. S. Contact EMV 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 Egov and Transit and Access end markets, with some improvement, are not sufficient to offset the decline in the banking revenue. As our Q4 guidance reflects, we're guiding for a further step down in this business.
We think over the intermediate term, revenue will hover around $150,000,000 per quarter, although Q1s are typically seasonally weak and our Q1 could be this time. Turning now to the Standard Products segment. Revenue was $320,000,000 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 $45,000,000 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 goal. We view the overall semi market as being next. In certain end markets like auto and FCD, 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've found a bottom in both SIS and digital networking, the 2 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 $500,000,000 in share repurchases. Specifically, we delivered revenue of $2,470,000,000 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 4 70 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 5.40 basis points of non GAAP operating margin expansion. On a $10,000,000,000 revenue run rate, this 5.40 basis points of margin improvement would suggest that we have already exceeded the $500,000,000 synergy run rate target within the 1st 3 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 6,500,000 shares at a cost of approximately $555,000,000 or $86.03 per share. This brings our total year to date share repurchases to just over $1,200,000,000 or 14,900,000 shares at an average price of $81.62 per share.
I would now like to provide our outlook for the 4th quarter. We currently anticipate Q4 revenue will be in the range of $2,400,000,000 to 2,500,000,000 dollars At the midpoint, we expect revenue to be about $2,440,000,000 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 52,000,000 dollars 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 $12,000,000 of IP license revenue.
It is unclear how the pending acquisition will impact our IP revenue pipeline going forward. And finally, I'd like to take a moment to discuss the status of the Standard Products divestiture. We have received all the regulatory approvals associated with the divestiture. The disentanglement process is going very well and we're on track to close the divestiture 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 and D and 6% to 8% for SG and 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 on 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 $2,300,000,000 from the divestiture. We will use the proceeds to reduce our gross debt and achieve our 2x net leverage target. We plan to redeem 3 tranches of debt.
First, we will redeem the $390,000,000 term loan due in 2017. 2nd, we will redeem the $500,000,000 5.75 percent senior notes due in 2021. And lastly, we will pay down approximately $1,000,000,000 of the term loans due in 2020. Push the redemptions gross debt will be approximately $7,500,000,000 with a weighted cost of debt of 3.6% and an annual interest expense of approximately $275,000,000 Putting this together with a Q4 cash balance and adjusted EBITDA that is consistent with Q3
will result in
net leverage of 2x. The ultimate amount of pay down of the 2020 term loans may vary up or down depending on what is required to achieve the 2x net leverage target. Lastly, we anticipate that our cash taxes in 2017 will be about $30,000,000 to $35,000,000 per quarter. With that, I'd now like to turn the call back to the operator for your questions. Operator?
Thank you. And our first question comes from the line of John Pitzer from Credit Suisse. Your line is now open.
Yes. Good morning, guys. Thanks for letting me ask the question. And 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 would you expect channel inventory to look like exiting sort of the what would you expect channel inventory to look like exiting sort of the December quarter?
So to be fair, John, it was up, I think it was $34,000,000 So it was up in terms of dollar level, but it was still at 2.5 months of inventory. So 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 that we're playing that opportunistically to have an impact from a top line revenue growth basis.
That's helpful. And then Dan, I just want to make sure I understand kind of some of the op margin targets you're talking 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 accelerate some of the organic sort of synergy gains at NXP ahead of the merger?
How should we think about that?
Yes. So, John, a couple of things. First, the guidance we gave is just provide clarity post the divestiture how the company will profile. It's 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 a run rate basis will 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'll start to see decision makings reflecting the combination of the 2 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 $12,000,000 of intellectual property revenue and there could be an impact from the 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.
That's helpful. Thanks guys.
Great. Thanks John.
Our next question comes from the line of Ross Seymore from Deutsche Bank. Your line is now open.
Hi, guys. Thanks for letting me ask a question. I guess the first question is on the deal with Qualcomm. How in your the price that Qualcomm is paying and you're accepting that price. Any sort of framework on how you view valuation would be helpful?
Well, I think Ross, it's really important to realize that the pre rumor price, this represents a 34 percent 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 portfolio to be able to drive the leadership that we wanted to be able to achieve. Specifically in autonomous driving, it's 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 ADAS solution as opposed to the areas where we have clearly identified leadership and can drive. So we think that's very complementary.
Although we have a good connectivity platform for our current portfolio, as we look out 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's clearly an opportunity for those shareholders that view the value creation opportunity as significant as we do for them to participate in that by actually buying Qualcomm shares.
Great. Thanks for that. And I guess as my follow-up, Dan 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 a 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 areas like automotive are doing better than people feared and you're growing well in FCD, but areas like SIS and maybe the high power RF might be a little disappointed or disappointing versus what you might have expected in May?
Yes. So Ross, thanks for the question. My answer will probably leave you a little unsatisfied. The revenue CAGR we gave you is exactly that, a CAGR over a 3 year window. I think we have a portfolio of businesses and like you point out, 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 there's got a couple of businesses that are living in a difficult neighborhood right now. And so rather than get into an exercise which guides 1 year out, What we want to do is just stick to the 3 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 get into the exercise of guiding it year out.
Yes. 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've 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. So I think it actually portrayed kind of a leading indicator relative to it. But as Dan said, we're really only guiding. We've only established that on a 3 year compounded growth rate basis and not any individual year end period.
Thanks guys. Thanks Ross.
Our next question comes from the line of William Stein with SunTrust. Your line is now open.
Great. Thanks for taking my question and I'll add my congratulations to the deal this morning. I've got 2 questions if I can. First, Dan, you highlighted that the company has already achieved its $500,000,000 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's more to go as the company progresses?
Yes. Thanks, Will. 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 goalpost gets you where you need to be.
Fair enough. 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 view this it sounds certainly like a content growth opportunity. Is this the initial ramp of V2X?
Is that meaningful part of the sort of separation? Or is there something else going on there? And any update on other VDEX design wins in general would be much appreciated. Thank you.
So Will, it's broad based. So I think the key is, is it's not VDEX. VDEX 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 to revenue, it's not in B2X.
It's pretty broad based but really focused on 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.
Our next question comes from the line of Stacy Rasgon from Bernstein Research. Your line is now open.
Hi, guys. Thanks for taking my questions. I want 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'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's up something like 4% or more. You guys are up barely 2%, which suggests to me that right now shareholders of Qualcomm are happier with the deal than shareholders of NXT. So why is this the best way to get what you need in order to achieve your growth goals?
So Stacy, I think it's obviously any value is what you negotiate between 2 parties. And we can't lose sight of the fact that it was a 34% premium to the pre disclosure, pre rumor period. And when you think about a transaction of this magnitude, a 34% premium is at least as we've been advised kind of pushing the limit associated with it. I think as we think about the future, the value of bringing the 2 companies together and bringing the most compelling platform in the industry going forward is just too significant of an opportunity to forego. And so we think that we've gone through this with our Board and our Board feels like 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 rumor price is a significant factor associated with it. And Peter Kelly, Stacy Peters joined us too here.
Stacy, I just wanted to say, I guess one thing. I mean overall, I do think 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 the unaffected price is very, very substantial. And I'm not a kind of corporate finance expert, but I think our stock will trade more on a kind of discount to close than anything else in the coming months.
But I do think this is a terrific deal.
Got it. I guess to follow-up on that though, I mean, why wouldn't you guys be willing to put in the work over the next 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 $110 on your own by the end of 2017? It seems like given the margin targets you've 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, 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 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 where 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 a very significant premium for a very large deal is something that we feel like is really a 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 to just create a powerhouse company.
Okay. Thank you. Thanks, Stacy.
Operator, we'll take one last call here this morning. We've got I want to keep this abbreviated today.
Okay. Our last question comes from the line of Tore Svanberg from Stifel. Your line is now open.
Yes. Thank you.
Rick, you mentioned the Secure ID business is bottoming, and I think you've said that for a few quarters now. It's expected to be down again sequentially the double digits for the December quarter. What are some of the milestones 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 really that business is really the technology that gives us the ability to provide security on a broad based set of solutions. Now in addition to that, of the contactless bank cards in China, which were kind of 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 kind of volumes that we've had in the past. And with some of the competitive practices and activities we see associated with contact base, we're actually being very selective in our participation associated with it.
And that's the reason why the business is not performing as we would have blacked for it to several years ago. We're down to a point where we think it's going to kind of be stable, but we've been at this point in the past. But 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 kind of at this bottom, it could be that in any individual quarter, it could go below that. But we think we're kind of at that run rate.
And actually as a percentage of the total volume, now the transit ticketing as well as the ecos 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 smooth 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.
Thank you for that. And as my follow-up, you mentioned the wireless space station market seems to still be soft and will probably remain soft. What are some of the data points to support that? And is there sort of any visibility as to when that market potentially start growing again? Thank you.
So the data points to support that for revenue, which continues to be hard to predict based on the supply chain
that's 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's virtually impossible for us to project when that will take place. We continue to be a leader in that space, so that's a 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's some opportunities for the early implementation of 5 gs, or massive MIMO that 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 continue to be 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 do realize it was an abbreviated call, but given that you announced our first thing this morning, we want to let you guys get back to writing your 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.