NXP Semiconductors N.V. (NXPI) Earnings Call Transcript & Summary

Good day, and thank you for standing by. Welcome to the NXP Third Quarter 2026 Earnings Conference Call. [Operator Instructions] Please be advised that today's conference is being recorded. I would now like to turn the conference over to Mike Lucarelli, Senior Vice President, Vice -- excuse me, Senior Vice President, Investor Relations. Please go ahead.

Thank you, Lisa, and good afternoon, everyone. Welcome to NXP's Third Quarter Earnings Call. With me on the call today are Rafael Sotomayor, NXP's President and CEO; and Bill Betz, our CFO. The call today is being recorded and will be available for replay from our corporate website. Today's call will include forward-looking statements that involve risks and uncertainties that could cause NXP's results to differ materially from management's current expectations. These risks and uncertainties include, but not limited to, statements regarding the macroeconomic impact on the specific end markets in which we operate, the sale of new and existing products and our expectations for the financial results for the fourth quarter of 2026. NXP undertakes no obligation to revise or update publicly any forward-looking statements. For a full disclosure of forward-looking statements, please refer to our press release. Additionally, we will refer to certain non-GAAP financial measures, which are driven primarily by discrete events that management does not consider to be directly related to NXP's underlying core operating performance. Pursuant to Regulation G, NXP has provided reconciliations of the non-GAAP financial measures to the most directly comparable GAAP measures in our third quarter 2026 earnings release, which will be furnished to the SEC on Form 8-K and is available on NXP's website in the Investor Relations section at nxp.com. I will now turn the call over to Rafael.

Thank you, Mike, and good afternoon. In we exceeded our outlook across all end markets and every region grew double digits year-on-year. Growth was led by our company-specific growth drivers in automotive and industrial, which grew 30% year-over-year and represent roughly 1/3 of our total revenue as well as continued strength in data center infrastructure. Revenue was $3.79 billion, up 19% year-over-year or up 22%, excluding the MEMS Sensor business. Non-GAAP operating margin was 37%, up 330 basis points and non-GAAP EPS was $4.20, up 35% year-over-year. These results are translating into strong free cash flow generation, enabling us to invest in the business and return cash to shareholders. To that end, our Board has authorized an incremental $5 billion for share repurchases, bringing total authorization to around $6.3 billion. Now turning to end market performance. Automotive revenue crossed $2 billion for the first time, up 17%, excluding sensors. This growth is driven by content gains led by our SDV portfolio in a flattish unit production environment. SDV revenue in Q3 is running above $1.5 billion annualized and remains well on track to reach our $2 billion 2027 target. We view the transition from the main base architectures to Sono and centralized compute as a multiyear upgrade cycle that will enable physical AI and autonomous capabilities in the vehicle. These new architectures create a need for system solutions that drive higher content across NXP's portfolio, including additional processing ag nodes, connectivity and power management. This results in 2 to 3x higher content per vehicle compared to today's architecture. This evolution is still in its early stages. In 2027, we will begin shipping our next-generation SDV processors, including the S32K5 Sono and S32N central compute platforms. We are starting to see material proof points of the SDV transition. [indiscernible] BTEC, the joint venture Volkswagen [indiscernible] announced yesterday, he has standardized its Sono platform on NXP S32K5 across both companies. This is a clear signal of the leadership of NXP's SDV portfolio and where the industry is heading. Engagements with our new platform continue to expand globally, and we now expect our first S32KF5 shipments in China as early as the first quarter of 2027. Software-defined vehicles are one of the first deployments of physical AI and the opportunity to reach as well beyond the car. The same building blocks of central compute sensing, networking and secure control are moving into robotics and other intelligent systems at the edge. This quarter, we secured our first S32K5 design win in human robotics with a leading U.S. global technology company. Now moving to industrial and IoT. Revenue was $802 million, up 39% year-over-year. The industrial portion of this end market grew nearly 50%, led by data center, factory automation and health care and now represents about 70% of industrial and IoT. As we mentioned in our Q2 call, AI-enabled processors will represent approximately [ 15% ] of industrial and IoT processor revenue in 2026, more than doubling from last year. Given market adoption of Intelligent Systems, we expect growth to continue in 2027. ARA, our discrete NPU is a key component of our AI portfolio. It continues to gain traction across industrial automation and automotive AI applications, and we expect to be in volume production in 2028. Now let me give you an update on our data center business. Given the strength we've seen year-to-date, we now expect our revenue to exceed the $500 million outlook provided earlier this year. Given the new products we're developing, combined with expanding customer engagements, we now expect this business to be over $1 billion in a couple of years. Going to communication infrastructure and other. Revenue was $503 million, up 54% year-over-year, driven by data center and secured cars. And lastly, mobile revenue was $411 million, down 4% year-over-year. Turning to our Q4 outlook. We're guiding revenue to $3.85 billion, up 2% sequentially and up 15% year-over-year or 18% excluding sensors. This would represent our fourth consecutive quarter of double-digit annual growth. At the midpoint, we expect the following trends in our business during Q4. Automotive is expected to be up in the low double-digit percent range year-over-year and up low single digits sequentially. Adjusted for the sale of the MEMS sensor business, our guidance implies a high teens percentage growth year-over-year. Industrial is expected to be up in high 20% range year-over-year and up in the low single-digit range sequentially. Mobile is expected to be down in the mid-teens percent range year-over-year, and up slightly on a sequential basis. And finally, communication infrastructure and other is expected to be up over 50% range year-over-year and up low single digits sequentially. And now I'd like to pass the call to Bill for a review of our financial performance.

Thank you, Rafael, and good afternoon to everyone on today's call. As Rafael has already covered the revenue drivers, I will turn to the financial highlights. Q3 was another strong quarter with record revenue, operating margin and non-GAAP EPS. Revenue grew 19% year-over-year and 8% sequentially to $3.79 billion. The growth was led by our company-specific growth drivers across software-defined vehicles electrification, connectivity, radar and industrial edge processing as well as continued momentum in our emerging data center business. Non-GAAP gross margin was 58.6% up 160 basis points year-on-year. Our gross margin performance reflects improved factory utilization and solid fall through higher revenues. Non-GAAP operating expenses were $810 million or 21.4% of revenue, reflecting strong operating leverage. This led to a non-GAAP operating margin of 37.1%, up 330 basis points year-on-year. Below the line, non-GAAP interest expense was $85 million, tax rate was steady at 18%, noncontrolling interest was $15 million, and results from our joint venture equity accounted investees were a $4 million loss. This resulted in non-GAAP earnings per share of $4.20, increasing 35% year-over-year or about 2x our revenue growth rate. Turning now to the balance sheet, cash flow and capital returns. Our balance sheet remains strong, providing flexibility to invest in our strategic growth priorities advance our hybrid manufacturing model and return capital to shareholders. We ended Q3 with $3.94 billion of cash and $10.98 billion of debt resulting in a net leverage ratio of 1.3x. Days of inventory declined to 148 days from 156 days in Q2, including approximately 13 days of prebuilt inventory related to our planned front-end factory consolidations. We expect to have approximately 15 days of prebuild inventory at the end of 2026. For the quarter, operating cash flow was strong at $1.26 billion, and net CapEx was $50 million, resulting in free cash flow of $1.21 billion or approximately 32% of revenue. During Q3, we invested $218 million between equity and access fees in VSMC and ESMC. A detailed breakdown of our joint venture investments is available in our historical financial model on our Investor Relations website. We expect to be over 75% complete with our JV investments by year-end. On a trailing 12-month basis, free cash flow was approximately $3.5 billion or 25% of revenue, in line with our long-term target. Over that same period, we returned $1.7 billion to shareholders through dividends and share repurchases. Most recently, shareholder returns have been below our long-term target as we prioritize deleveraging strategic acquisitions and investments in our manufacturing joint ventures to support future growth and gross margin expansion. Moving forward, we plan to accelerate our buyback activity in Q4 and 2027. Consistent with that commitment, the Board authorized a new $5 billion share repurchase program bringing total authorization to $6.3 billion, representing around 10% of our current market capitalization. Overall, we remain committed to returning 100% of our excess free cash flow to shareholders over the long term. Now turning to our expectations for Q4. We expect revenue of $3.85 billion, plus or minus $100 million, which is up 15% year-on-year or up 18% adjusted for the sale of our sensors business and up 2% sequentially. We expect non-GAAP gross margin of 59%, plus or minus 50 basis points, driven by higher revenue and manufacturing utilizations. We expect operating expenses of $830 million, plus or minus $10 million. The increase sequentially is primarily driven by our new product tape-outs to support our trusted physical AI strategy. At the midpoint, the results in a non-GAAP operating margin of 37.5%. Below the line, we expect non-GAAP financial expense to be $79 million and our non-GAAP tax rate to be approximately 17.5%. We expect noncontrolling interest to be $14 million and $5 million of losses in our joint venture equity accounted investees. This implies Q4 non-GAAP earnings per share of $4.36 at the midpoint, an increase of 30% year-over-year, demonstrating continued earnings power. Turning to Q4 uses of cash. We expect capital expenditures to be approximately 3% of revenue and equity payments to VSMC of $86 million and ESMC of $60 million. Looking ahead into 2027 and for your model and considerations. We will continue to drive double-digit growth in revenue. We plan to expand our gross margins to 60% during 2027. We expect operating expenses for the first half to be around 23% of revenue driven by new product introductions and second half be below 23%. Assuming a non-GAAP annual effective tax rate of 17.5%, we now expect joint venture investing losses to be around about $80 million for the full year and suggest using about a $10 million loss for Q1 and a $20 million loss for Q2. Capital expenditures to be around 5% as we plan to bring on more back-end capacity online in 2027 and build out our new assembly and test facility in Malaysia to be ready for production in 2028. Lastly, we will continue to generate healthy levels of cash and we plan to accelerate capital returns to our owners. Next, to better understand our business, we plan to realign our end market revenues beginning in 2027. In addition, we plan to host our Investor Day on March 3 in Boston, where we will update our strategic and long-term financial model. And finally, I'd like to thank Jeff Palmer, who has served us as the Head of Investor Relations for the past 16 years and thank him for his many contributions to NXP. I would like to now turn the call back to the operator for your questions.

[Operator Instructions] Our first question will be coming from the line of Jim Schneider of Goldman Sachs.

I was wondering if you can maybe talk a little bit about the customer behavior you're seeing across your OEM customers specifically, are you seeing signs of them restocking at all in a more aggressive way than they had in past quarters? And give us a sense of the customer commentary in terms of what's happening with lead times and how they're responding to that.

Yes. So Jim, thank you for the question. I assume this is an auto question. So in the context of auto, we're not seeing anything noticeable that would suggest to broad-based restocking. Now from a visibility perspective, I think visibility is greatly improved. And so lead times have extended, but also has resulted in better visibility. The other kind of, I would say, the other trend in the market in automotive is OEMs are getting more involved in providing that guidance directly to companies like us. And so there's a lot more intimacy from a customer relationship perspective with respect to the needs throughout the year. So I feel like we have good visibility on what that supply is going to be required in the top of products we're going to need to deploy.

Yes, yes. And then as a follow-up, I just wanted to sort of ask, it's very helpful to see the solid guidance for 2027. Can you maybe give us a sense about by end market, some of your -- the places where you have greatest underlying confidence in sort of outperforming that overall double-digit outlook you provided and other areas where you see there's a little bit more uncertainty.

Sure. Well, I think what is working in -- when it's working in 2026, that will continue in 2027. I mean what your question is what's driving our confidence in the growth in double digits in 2027 and continues to be the areas that we're focused on, SDV adoption continues. As a matter of fact, it's just barely starting, and we see several ramps, especially in the second half of 2027, we have very important ramps in our SDV portfolio. The same thing goes to industrial and IoT. The adoption of AI continues to add content gains in industrial and IoT and it's quite strong. And the deployment that we're barely starting on the control plane and data center continues to play out for us.

Our next question will be coming from the line of Thomas O'Malley of Barclays.

Maybe this is for Bill. When I look at December guidance, I think you guys are guiding to 59% gross margin. It's a pretty big step up in incrementals from September. I think it's 85% quarter-over-quarter, close to 70% year-over-year. Obviously, volume is some component of that, but maybe walk through some other things that are driving that, just as that's a big step up from what you've seen over the last 3, 4 quarters.

Absolutely, Thomas. A couple of points on gross margin. First, they're performing to our expectations and as we share the -- continue to expand into Q4. And I would say our gross margin improvements are very structural in nature. They're driven by a combination of the higher revenues the higher utilization. As I mentioned, we're running last -- I gave guidance running in the mid-80s. They are running in the May 80s now. We expect them to continue in Q4 in the mid-80s. And we're actually, in 2027, expect them to run in the high 80s. Clearly, product mix plays a role and then obviously, improved operational efficiencies. I would also say our gross margins have nothing to do with the price increases that we're seeing at the moment because all we're doing with the price increases is offsetting the higher inflationary costs that we're passing on to our customers. And then I think overall, we expect gross margins to continue to expand, achieving that 60% during 2027. And furthermore, I think they'll expand above 60% in 2028 with the ramp of our VSMC joint venture that we shared about in the past.

Do you have a follow up?

I do. Just some seasonality. So I'm sure everyone will have slightly different numbers. But by my numbers, auto was a little ahead of seasonal in September. And then your guide is kind of low single digits sequentially my December traditional seasonality is close to like mid- to high single digits. Any reason why the delta there? Is it because of some of the stronger quarters that you bought in June, September? Or are you calling out anything in particular that's worth noting?

I think you're talking about auto specifically. Is that correct? If that's so ...

Auto specifically into December.

So you're right, auto has been quite strong this year and above seasonal, I would say, almost every quarter this year. Looking at 4Q, I'm not sure there's a lot of range on seasonality, a lot of different years be years, 3, 5, 7, 10 years. I think it's seasonal in auto is probably flat to up slightly. So I think that 2% growth is above seasonal. That's how I would view that. So I would say strong trends continue in auto. So that's a straightforward answer on the automotive market specifically.

And our next question is going to be coming from the line of Joshua Buchalter of TD Cowen.

Maybe following up on Tom's one. Any help you can give us on what you're seeing in the overall pricing environment now? And then as we look into 2027, I know in some prior years, there's been sort of a step down in gross margins due to the annual pricing resetting. Should we be expecting a step down in 1Q again looking into 2027 this year?

Yes. Let me start off with the pricing. Going into 2026, we expected a low single-digit price decline. Now as we plan to exit 2026, we expect pricing to be neutral for the year for '26. Clearly, for 2027, we continue to see higher input costs in many areas. And unfortunately, we will pass those to our customers to ensure our gross margins are not impacted. I think we expect revenue to also be supported by the mix of our products, as Rafael shared, especially in the SDV portfolio with our new solutions that drive higher average selling prices in 2027 because of the portfolio where SDVs carry 2 or 3x more value than our traditional portfolio. But in the short term, I would say pricing is doing what we expect and we're pass them along. Neutral, I'd say, Q3 maybe plus 1%. 1% was pricing in Q3, another 1% in Q4. So it keeps it neutral for the whole year for 2026.

Josh, maybe let me add -- this is Rafael. Let me add a high level perspective here and put aside the variable input cost for a second here. The way we see this is we see a structural shift in the industry with respect to pricing, right? I like the past decade where annual price erosion was common. Today, I think semiconductors account for a larger share of the value and the innovation and the systems. And I think that creates opportunities for much better value capture, right? This has nothing to do with input costs, right? It's just the shift in value with respect to semiconductors and ultimately on the systems. Sure, competitive pressures will always remain. But I think what we expect is the historical pattern of annual price erosion to actually moderate over time. And I think it's going to -- over time, I think it's going to make pricing less of a headwind year-over-year.

And to follow up, you mentioned that you're not seeing any signs of widespread restocking. It seems like there's been pretty mixed commentary from the industry over the last couple of quarters about whether restocking is going on or not. How much of, I guess, what you're seeing is proactive conservatism on your part similar to how you handle the previous cycle? Or is there anything different about your portfolio or products that would -- or exposure that would give you a different cadence of restocking than some of your peers that are saying that they're seeing it already.

Josh, we're not seeing it, right? I can only tell you what we see. We're just not seeing it. And the fact that our core products are at the core of the software-defined vehicle I don't see how we -- if there was restocking, we would see it, right? What it has, it has been conversations by some OEMs, right, to be able to actually have some safety stock put in place given the tightness in the supply right now, but it's yet to occur, right? So I mean I acknowledge some of the headlines by some Tier 1 OEMs, but we have not seen the restocking. And given the fact that our products are core to the core function of the vehicle, if there were any restocking, we will see it.

Yes. Maybe just to add, remember, for automotive distribution, we service that by about 40%, and we have a really good control on that.

And the next question is coming from the line of Blayne Curtis of Jeffries.

I just want to start on the auto segment. Obviously, you have a lot of structural drivers with SDV. I was curious on the electrification side, what are you seeing? I think Texas saw an uptick, curious with gas prices. maybe start with that.

Yes. This is Bill. We are seeing strength across all our company-specific growth drivers in automotive, and last year, electrification was going through inventory digestion and our new products were delayed a bit. But those are performing quite well this year and catching up and I would say, growing above that growth rate that we provided during Investor Day, specifically in electrification. If I step back and look at total SAAR total SAAR is slightly down, but the penetration of EVs, including hybrids, combine that, that's actually growing. I mean I think total production this year is forecasted to be about 47.5% roughly of SDVs and next year is expected to be across the 50% mark to about 55%. So the 47% this year compared to last year was 41% is growing 12%. The forecast is to grow another 15% of that penetration rate. So from a macro standpoint, we do see SDVs continuing to grow globally. And as you know, it carries 2 to 3x more semi content in the industry compared to a regular ICE vehicle.

And then Bill, don't kill me for this, but I wanted to ask you any early thoughts on March, either kind of by segment overall.

For the first quarter, you're saying? Sure. Yes. So I knew someone asked the question, Blayne. I thought [indiscernible] but it was you, Blayne, you are ahead of the queue. So again, this is not a guidance, a wide range on these expectations, give my normal caveats there. But typically, 1Q for us is down about mid-single digits. What drives that mid-single-digit sequential decline is mobile down mid-teens sequentially. In automotive, industrial IoT and CONDIPRA is down kind of low to mid-single digits, call it, 3%, 4%, 5% sequentially. Again, this is not guidance. This is just overall trends over the past 5, 10 years in our business.