NXP Semiconductors Q2 2022 Earnings Call Transcript

Quartr
Provided by Quartr
July 25, 2022

Key Takeaways

  • NXP’s Q2 revenue of $3.31 B was above midpoint guidance, up 28% year-over-year, and achieved a record 36.4% non-GAAP operating margin.
  • Automotive revenue rose 36% to $1.71 B and Industrial & IoT climbed 25% to $713 M, both beating guidance, while Mobile and Communication Infrastructure were in line with expectations.
  • Supply remains constrained, with only ~80% coverage of risk-adjusted demand and over 80% of products quoted at >52-week lead times, leading to active backlog derisking.
  • For Q3, NXP guides to $3.425 B in revenue (+20% y/y, +3% sequential) and around 36.1% non-GAAP operating margin, driven by ongoing strength in automotive and industrial markets.
  • NXP ended Q2 with net debt/EBITDA of 1.5×, generated $551 M of non-GAAP free cash flow, and returned over 100% of trailing-12-month free cash flow via dividends and buybacks.
AI Generated. May Contain Errors.
Earnings Conference Call
NXP Semiconductors Q2 2022
00:00 / 00:00

There are 12 speakers on the call.

Operator

Good morning, ladies and gentlemen. Thank you for standing by, and welcome to the NXP Second Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen only mode. After this speaker's presentation, there will be a question and answer Please be advised that today's conference maybe recorded. I would now like to hand the conference over to your speaker host today, Jeff Palmer.

Operator

Please go ahead, sir.

Speaker 1

Thank you, Olivia. Good morning, everyone. Welcome to NXP Semiconductor's 2nd quarter 2002 earnings call. With me on the call today is Curt Sievers, NXP's President and CEO and Bill Betts, our CFO. The call today is being recorded and will be available for replay from our corporate website.

Speaker 1

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 are not limited to, Statements regarding the continued impact of the COVID-nineteen pandemic on our business, 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 Q3 of 2022. Please be reminded that NXP undertakes no obligation 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 Q2 2022 earnings press release, which will be furnished to the SEC on Form ks and is available on NXP's website in the Investor Relations section at nxp.com. Now I'd like to turn the call over to Kurt.

Speaker 2

Thank you very much, Jeff, and good morning, everyone. We appreciate you all joining our call today. Let me begin with a review of our quarter 2 performance. Our revenue was $37,000,000 better than the midpoint of our guidance, With Automotive and Industrial and IoT above our guidance, while trends in the Mobile and Communication Infrastructure markets were in line with our expectations. Taken together, NXP delivered quarter 2 revenue of $3,310,000,000 an increase of 28% year over year.

Speaker 2

Our non GAAP operating margin in quarter 2 was a record 36 400 basis points better than the year ago period and about 30 basis points above the midpoint of our guidance. Our results reflect strong execution with better than guided operating leverage and profit fall through on the incrementally higher revenue on top of improved gross profit. Now let me turn to the specific trends in our focus end markets. In Automotive, revenue was 1,710,000,000 up 36% year over year, near the high end of guidance. In Industrial and IoT, Revenue was $713,000,000 up 25% year on year, better than our guidance.

Speaker 2

In mobile, revenue was $388,000,000 up 12% year on year, in line with our guidance. And lastly, Communication Infrastructure and Other revenue was $498,000,000 up 20% year on year, in line with our guidance. Looking at the trends across our end markets, We are not naive to believe NXP is immune from the clearly weakening macro environment. Customer demand versus supply, inventory per channel, per end markets and per geography. When we look at demand signals, we have a high level of confidence in the intermediate term outlook.

Speaker 2

This is especially true in terms of demand trends in the automotive and industrial markets, which accounts for the majority of our total revenue. While there is a well documented weakness in the low end Android handset market, it is important to note that our mobile business is more biased towards the premium tier members. And in aggregate, our mobile business accounts for only about 12% of our total revenue. In terms of the PC and Broad Consumer Electronics markets, there are much smaller contributors in the IoT portion of our Industrial and IoT segment. In terms of customer behaviors, We do not see any substantial weakening within the auto and industrial customer base.

Speaker 2

Relative to long term committed customer demand, A large percentage of our major customers continue to firmly desire supply assurance commitments, which are facilitated by placing non cancelable, non returnable orders with us throughout In terms of key operating metrics, which inform our short term decisions, demand continues to outpace our gradually and incrementally improving supply capability. Furthermore, even as we actively de risk our existing backlog for potential double or any stale orders, we judge supply to only address approximately 80% of the underlying demand. Additionally, we continue to redirect shipments to those customers, which are at risk of going lines down, thus avoiding excess or stagnant inventory buildup. When looking at customer inventory, We continue to see a dysfunctional supply chain, which struggles to get the right product mix and complete kits to the correct location in the Extended Automotive and Industrial Markets. Now in terms of our own on hand inventory, It has increased through quarter 2 on a dollar basis consistent with orders placed with suppliers and internal build plans.

Speaker 2

The primary area of increase is in raw material and work in progress in order to fulfill firm customer commitments in future and especially in quarter 3. On a days basis, DIO was 94, an increase of 5 days sequentially and closer to our long term target of 95 days. Now moving to the distribution channel, which services about half of our total revenue, inventory continues to remain stubbornly below our long term targets. During quarter 2, the months of supply in the channel was barely 1.6, which is about a month below our long term target, and it is now the 7th consecutive quarter of an exceedingly tight supply situation in the channel. Finally, let me speak to our ability to service customer requirements.

Speaker 2

Lead times continue to be extended with more than 80% of all products being quoted at 52 weeks or greater, which is actually on a similar level to last quarter. So in summary, against this dynamic backdrop, our second quarter and the first half of the year was a good beginning to what we view will be a positive year for NXP. We do continue to see the second half of the year greater and the first on an absolute dollar basis. Now let me turn to our expectations for quarter 3. We are guiding revenue at $3,425,000,000 up about 20% versus the Q3 of 2021, within a range of up 17% to up 22% year on year.

Speaker 2

From a sequential perspective, this represents growth of about 3% at the midpoint versus the prior quarter. At the midpoint, we anticipate the following trends in our business. Automotive is expected to be up in the low 20% range versus quarter 3 2021 and up in the mid single digit range versus quarter 2 2022. Industrial and IoT is expected to be up in the low 20% range year on year and up in the mid single digit range versus quarter 2 2022. Mobile is expected to be up about 10% year on year and down in the low single digit range versus quarter 2 2022.

Speaker 2

And finally, Communication Infrastructure and Other is expected to be up in the low double digit range versus the same period a year ago and up in the low single digit range on a sequential basis. Let me summarize. The growth we have anticipated for 2022 is materializing, notwithstanding the clear macro crosscurrents and the continued supply challenges. We do continue to see strong customer demand in the automotive and industrial segments as well as within our company specific accelerated growth drivers. Overall, Demand continues to outpace increasing supply.

Speaker 2

However, we are staying paranoid about the macro environment. And hence, we will continue to work very diligently and in a very disciplined manner to assure inventory across all end markets remains lean. And with that, I would like to pass the bill over to you the call over to you, Bill, for a review of our financial performance.

Speaker 3

Bill? Thank you, Kurt, and good morning to everyone on today's call. As Kurt has already covered the drivers of the revenue during Q2 and provided our revenue outlook for Q3, I will move to the financial highlights. Overall, our Q2 financial performance was very good. Revenue was $37,000,000 above the midpoint of our guidance range and both non GAAP gross profit and non GAAP operating profit were above the midpoint of our guidance.

Speaker 3

Now moving to the details of Q2. Total revenue was $3,310,000,000 up 28% year on year and above the midpoint of our guidance range. We generated $1,920,000,000 in non GAAP gross profit and reported a non GAAP gross margin of 50 7.8%, which is up 170 basis points year on year and both above the midpoint of the guidance range as a result of higher revenue and positive product mix. Total non GAAP operating expenses were $724,000,000 or 21.9 percent, up $98,000,000 year on year and up $36,000,000 from Q1, in line with our guidance range, but below our long term model. From a total operating profit perspective, Non GAAP operating profit was $1,190,000,000 and non GAAP operating margin was 36%, up 400 basis points year on year and both above the midpoint of the guidance range.

Speaker 3

Non GAAP interest expense was $97,000,000 with cash taxes for ongoing operations of $150,000,000 or approximately 13.7 percent effective cash tax rate and non controlling interest was $13,000,000 Stock based compensation, which is not included in our non GAAP earnings was $89,000,000 Now I would like to turn to the changes in our cash and debt. Our total debt at the end of Q1 was $11,160,000,000 up $587,000,000 sequentially as we issued $1,500,000,000 of new debt and simultaneously retired early the $900,000,000 of debt, which was due in June of 2023. Our ending cash position was $3,550,000,000 up $862,000,000 sequentially due to a combination of the previously mentioned financing, CapEx investments and capital returns during Q2. The resulting net debt was $7,620,000,000 and we exited the quarter with a trailing 12 month adjusted EBITDA of $4,960,000,000 Our ratio of net debt to trailing 12 month adjusted EBITDA at the end of Q2 was 1.5x and our 12 month adjusted EBITDA interest coverage was 12.7x. Turning to working capital metrics, days of inventory was 94 days, an increase of 5 days sequentially and close to our long term DIO target of 95 days as we continue to experience incrementally improved supply trends.

Speaker 3

The increase in on hand inventory was primarily in raw materials and work in process to support revenue growth in subsequent periods, especially Q3. We continue to closely manage our distribution channel with inventory in the channel at 1 point 6 months well below our long term target. Days receivable were 27 days, flat sequentially and days payable were 94, an increase of one day versus the prior quarter. Taken together, our cash conversion cycle was 27 days, reflecting strong customer demand, solid receivable collections and positioning for customer deliveries for future periods. Our working capital management and balance sheet metrics continue to be very strong.

Speaker 3

Cash flow from operations was $819,000,000 and net CapEx was $268,000,000 or 8.1 percent of revenue, resulting in non GAAP free cash flow of $551,000,000 or 17 percent of revenue. During Q2, We paid $222,000,000 in cash dividends. On a trailing 12 month basis, we have returned 132% of our non GAAP free cash flow back to the owners of the company, consistent with our capital allocation strategy, The cash flow generation of the business continues to be excellent. Turning now to our expectations for Q3. As Curt mentioned, we anticipate revenue to be about $3,425,000,000 plus or minus about 75,000,000 At the midpoint, this is up 20% year on year and about 3% sequentially.

Speaker 3

We expect non GAAP gross margin to be about 57.8 percent plus or minus 50 basis points. Operating expenses are expected to be about $743,000,000 plus or minus about $10,000,000 which is up about 3% sequentially driven by hiring, especially new college graduates and our normal project spend. Taken together, we see non GAAP operating margin to be 36.1 percent at the midpoint. We estimate non GAAP financial expense to be about 95,000,000 and anticipate cash tax related to ongoing operations to be about $160,000,000 or about a 14% effective Cash tax rate consistent with our communicated model. Non controlling interest should be about 13,000,000 For Q3, we suggest that for modeling purposes, we use an average share count of 265,000,000 shares.

Speaker 3

Finally, I have a few closing comments I'd like to make. First, as Curt mentioned in his prepared remarks, We have attempted to de risk our Q3 outlook given the combination of the uncertain macroeconomic environment and well document the weakness in the mobile and consumer end markets. Despite these potential risks, Customer demand in the automotive and industrial remains strong and greater than our immediate ability to supply. Secondly, from a unique revenue growth standpoint, since November of last year at Investor Day, We discussed 6 accelerated growth drivers. Looking at our first half performance of 2022 versus the same period last year, We are very well on track to the targets we presented.

Speaker 3

Lastly, our people. We are very proud of our all our team members globally and especially those in China, who continue to overcome severe COVID restrictions, while simultaneously dealing with global supply chain disruptions this past quarter. We continue to be amazed that our employees' incredible dedication and resilience and for powering through these extremely tough times. Our results are a testament to their hard work. With that, thank you.

Speaker 3

And I'll now turn it back over to the operator for questions.

Operator

Thank you. One moment for our first question.

Speaker 4

My first question relates to your reference to risk adjusted backlog. Bill, you've done a both Bill and Kurt have done a bit of explaining that in the prepared remarks. But I'm wondering if you can comment on your nominal backlog. And it sounds like the reasoning is related to More things you see outside of the company than what you see in your actual order trends. Maybe you can talk about the thought process and the magnitude of that risk adjustment?

Speaker 2

Yes. Thanks. Good morning, Will. What I tried to convey is indeed, 1st and foremost, that for the foreseeable period ahead of us, we are actually only covered with 80% with our supply against the true demand which we see. And when I say true demand then that comes back to the risk adjustment.

Speaker 2

For good reasons, we have never revealed the size of our backlog Through the past quarters, because I think I've always been clear that we've always believed inside that huge backlog There might be double orders, which is just normal human behavior in times of shortage. Now over the past quarters, We have clearly learned much more from a transparency perspective about the true minimum needs of our end customers across all markets. And we have very rigidly applied that knowledge to try and actually risk adjust That backlog in order to come to a number which is maybe more meaningful. And I just want to emphasize after doing that Will, We still have only that 80% coverage of our increasing supply capability against that risk adjusted demand. So what we try to say is, we try to be realistic around the size of the backlog.

Speaker 2

That's why we risk adjusted And that is different in each of the markets we serve. The result of it leads in the foreseeable future to 80% coverage of the adjusted demand.

Speaker 4

Great. That helps a lot. Maybe the follow-up to that, it feels pretty natural, is What is the company doing to improve with internal capacity, your current foundry partners? And is there any effort underway to and foundry relationships that could allow you to sort of come closer to meeting your customer demand? Thanks so much.

Speaker 2

Yes. Clearly, we absolutely stick to our hybrid manufacturing model. We continue to believe and I think the results of the past 6 to 8 quarters have given good evidence of that, that this is for the portfolio we are serving a very superior model of serving the needs of our customers. And what that means is that indeed we are working on both ends of the equation. About 60% of our current wafer Supply is coming from foundry partners and that is more and more predominantly tuned into CMOS logic processes, Especially when it comes to 300 millimeter and when it is below 90 nanometers.

Speaker 2

And in there, we are Definitely ramping up significantly our partnerships and our strategic collaboration with key foundry partners. We've spoken about this in the past and that is also what clearly is helping us in the past quarters. In the coming quarter, we talked about the sequential growth going forward in incrementally increasing our supply. At the very same time, we are remodeling our own factories, which are all 200 millimeter facilities to be the prime place for manufacturing proprietary specialty processes, which are unique to NXP. And by moving out more of the CMOS to our foundry partners, we are creating more space internally in our existing to serve the increased and ever growing needs for these proprietary technologies going forward.

Speaker 2

So that is a refinement of the hybrid model, But it's still important that I really want to emphasize we stick to the hybrid model, which again has also allowed us to outgrow our key peers in that market over the last 6 quarters.

Speaker 4

Great. Thank you.

Operator

Thank you. One moment for our next question. And our next question coming from the line of Ross Seymore with Deutsche Bank. Your line is open.

Speaker 5

Hi, guys. Thanks for letting me ask a question. Kurt, I wanted to dive a little bit into the potential disconnect with you guys doing everything you can to manage the backlog, I appreciate what's going on in macro, but yet the guidance seems fine in the quarter and you said you're going to grow in the second half versus the first. So I guess as you look at that, when do you think it will start to be a little bit more apparent, what macro is doing if it Stays like it is. And maybe more pointedly, it's great that you're growing in the second half.

Speaker 5

But last quarter, you said you thought you would grow sequentially in the 3rd and fourth So does that growth in the second half imply that you still believe you will grow sequentially in the Q4?

Speaker 2

Yes. So thanks, Ross. First of all, indeed, we try to make sure that you all hear loud and clear that we are Not neglecting the crosscurrents in the macro, which have also started to be visible in our orders, especially in the mobile market. Now mobile is for us relatively small, so it doesn't really impact the whole company very much. But the principle we are applying is to be hyper disciplined and hyper paranoid to not grow any inventory down the chain.

Speaker 2

So we try to stay there as disciplined as we can be. And the first Area where we are applying this as we speak is in our mobile market and to a certain extent in the small portions of consumer More consumer oriented segments inside our Industrial and IoT sector. Now when you ask about the second half, Yes, we are confirming within that more turmoil macro that the second half is going to grow sequentially Over the first half in absolute dollar terms, we just gave you the guidance for quarter 3. I don't have a crystal ball for quarter 4, but I can tell you that we remain totally sold out for the rest of the year. I also tried to highlight that supply continues to ramp up sequentially into the next quarters.

Speaker 2

So I cannot really make a firm assessment on what mobile and other consumer markets will do into the Q4. But clearly from the strength in the automotive and industrial sectors which we are serving, We are quite optimistic for the second half to also continue to grow sequentially.

Speaker 5

Thanks for that color, Kurt. I guess my follow-up one for Bill. I noticed This is the Q1 in, I think, couple of years that you guys didn't repurchase any shares. Lots of people trying to read into what that may or may not Mean, but can you go into the thinking of what led you to stop the buyback for a quarter?

Speaker 3

Yes. First off, thanks Ross for your question and I wouldn't read too much into it. First off, there's no change to our capital return policy. As stated many, many times, we will return all excess free cash flow On a trailing 12 month basis, during Q2, in my prepared remarks, we returned 132% of our 12 trailing 12 months for free cash flow. Remember, we also raised our dividend in the quarter by 50%, And we still have authorization buyback of over $3,000,000,000 from our Board.

Speaker 3

At the end of the year, we do expect to return to be at least 100% or higher consistent with our stated policy.

Speaker 6

Thank you.

Operator

Thank you. One moment for our next question. And our next question coming from the line of C. J. Muse with Evercore ISI.

Operator

Your line is open.

Speaker 7

J. Muse:] Yes, good morning. Thank you for taking the question. I guess first question, Kurt, I was hoping you could speak to how you're thinking about the overall state of the auto industry this morning Since Autonomous, but it looks like your second half prior outlook was perhaps a bit aggressive. At the same time, you have OEMs that are waiting for those golden And hopefully, we'll get those.

Speaker 7

But as I look at your mix, obviously EV and ADAS along with higher input Costs and higher ASPs are sustaining excellent growth for you guys. So curious, how do you see things playing out? When do you think we can normalize in the auto supply demand side of things? Is that in 2023 or might that be longer?

Speaker 2

Yes. Thanks, C. J. That's not an easy question. I dare to follow IHS in the first place, which I think hasn't changed The forecast for this year for the SAAR very much, I think they continue to speak about like a 5% growth of the SAAR this year, which would get us to well, just short of 81,000,000 cars this year.

Speaker 2

However, that includes A 9% half two over half one growth in car production this year, which is not a big surprise because I think half one again has suffered Massively from semiconductor shortages and especially in the Q2, it has suffered a lot from the COVID shutdowns in China, which impacted mainly the Japanese, Chinese and Southeast Asian car production. I mean, there was a little less pronounced for the Western world, but a lot in China and Japan. And mind you that China continues to be the largest car country in the world. So from a shorter term perspective, C. J, I think half 2 car production will grow quite nicely over the first half finally.

Speaker 2

And that trend should also continue according to IHS into the next year, which I think will be another 8% growth or so. All of that in our views is still probably short of consumer demand. Now it will depend on the macro and looming recessions in different geographies to what extent consumer demand is muted for cars. But we think The car production is so low and so far below the highs in 2018 or early 2019 That even if consumer demand is muting, there is still a gap such that I think it's very realistic to assume that car production continues to grow. Now at the same time and I know we've discussed it to DAS before, the bigger factor for us however certainly remains the content increase.

Speaker 2

And from a content increase, it's just amazing every quarter I come with new numbers here, especially EV penetration has accelerated again. I think the latest forecast for this year is now that 26% of the global car production is going to be ex EVs. I think last quarter we talked about 23%. I mean these are massive numbers And this 26% this year is in absolute terms of 46% year on year growth in XCV Production. And again, mind you that with our battery management, inverter control and many, many microprocessors and microcontrollers associated With ex EVs and the overall semiconductor, which is more than 2x relative to combustion engine cars, This continues to be a massive momentum ahead of the car production, which in itself is now also growing.

Speaker 2

So sorry for the lengthy reply, but we are quite animated about the fact that there continues to be a big gap there And the content increase is pulling the cart for us.

Speaker 7

That's very helpful. As my follow-up, I heard the earlier comments around Absolutely adhering to your hybrid manufacturing model, but you did speak to optimizing your internal capacity and considering The 8 inches 90 nanometer and above demand that's out there, is there a point in time where you would need to consider a new JV Factory with TSMC?

Speaker 2

Well, first half of your question, yes, second half, I will not comment to because The matter of the fact is, yes, what I described will very naturally with continuously growing demand leads to a moment Where our internal 4 walls existing capacity even after the reshuffling I described will not be enough to serve future demand. So yes, we will do something about it, but there is various different ways of achieving this CJ. So don't get Got locked down into the idea with TSM. There is all sorts of options which we can do, including, but again not But also including the opportunities which are being provided by the chipsets in Europe and the U. S, We are the majority of our facilities, Ara.

Speaker 2

Very helpful. Thank you.

Operator

Our next question coming from the line of Vivek Arya with Bank of America. Your line is open.

Speaker 8

Thanks for taking my question. Kurt, I wanted to ask about NCNR orders and pricing dynamics. Let's say if Auto production is flat or down next year. I'm curious how enforceable are these NCNR orders and how defensible Will the pricing strength be in that kind of market?

Speaker 2

Yes. Thanks, Vivek. Let me start with the second part, the Pricing. Given the very stubborn imbalance between supply and demand in most of the technologies needed for automotive, I have a very high confidence that the pricing is very stable. I would actually and maybe unfortunately go a step further.

Speaker 2

We do continue to see our input cost rising also into next year, which would indeed force us to also continue to raise our pricing. So rather than thinking about pricing to become software again, I believe that especially in the automotive environment Where this supply demand imbalance is here into next year, there is a chance that pricing continues to go up into next year. The number of times we have a very clear and very much Transparent policy here that we are increasing our prices to the customers in line with the input cost Which we are experiencing in order to protect our gross margin percentages. So on that side from a pricing perspective, Even with a flat car production or maybe as you said, as you suggested, which I don't think is going to be the case reducing car production, I think that would still be the case because of the content increases which are driving so much demand anyway. Now the other side was the supply situation per se.

Speaker 2

In a way, I answered it. Given content increases Surpassing the impact or outbalancing the impact of the SAAR so much, I unfortunately believe that even in a soft reduction of SAAR next year, we would continue to see in many technologies An imbalance between supply and demand next year.

Speaker 4

Got it.

Speaker 8

And then my follow-up is on the margins. So gross margins are getting towards the high end of your target. And I think EBIT margins, from what I see you're guiding a little bit above the high end of your target model. Is it time to revise the model? And let's say, if Q4 grows sequentially, can margins also continue to expand?

Speaker 8

Is there still a positive leverage in the model? Thank you.

Speaker 3

Hey, Vivek, this is Bill. I'll take that question. So related to the high end of our model, yes, we are performing at those levels At this current time, I'd just like to remind everyone that we'll focus on growing our top line of revenue and a faster growth At the top line of 1% will be greater and better than a 1% change in our margin as we go forward. We're not going to update our long term model every quarter For every year and we will revisit this during our normal 3 year long term model that we provide or if there's any material change to our business model. So no change.

Speaker 3

We feel very confident to run, like I mentioned last call, in the toward our high end of the model for the rest of the year. Thank you.

Operator

Thank you. One moment for our next question. And our next question coming from the line of Gary Mobley with Wells Fargo. Your line is open.

Speaker 4

Hey guys, thanks for taking my question. Appreciate your commentary with respect to how you derisked in your 3rd quarter guide, The different macro issues and whatnot, but I want to ask conversely what can go right in the last 2 plus months of the quarter To maybe hit the high end of the expectation as it relates to COVID mitigation in China, kitting issues, additional supply and whatnot.

Speaker 2

Well, Gary, I mean, we give the guidance with the midpoint in the range in order to comprehend Risks and Opportunities at the Same Time. I think the elements you just listed are certainly part of both potential risk and potential opportunities. Again, we carefully Thought about weighing the upsides and downsides, and that's why we landed on the midpoint of 3, 4.25 As we just guided a couple of minutes ago, I would say the following. For us, The overall sentiment is given the big percentage in our revenue is obviously dominated by how automotive and industrial markets are going. And here, our guidance for the next quarter is really driven by what we hear from our customers.

Speaker 2

I mean, it's such a short period of time in a way that it is really just tuned To the short term customer confirmed orders and our supply capability. And the way I would put it, Q3 upsides are probably more than anything dominated by our supply capabilities since we are sold out for the quarter.

Speaker 4

Appreciate the color, Kurt. As my follow-up, I wanted to ask about the 6 accelerated growth drivers that you began to outline Stan, continue to outline. Of the 6 and looking out over the next 12 months, which of those 6 would you expect to be the biggest contributor to your revenue growth?

Speaker 2

Well, the 6 accelerated growth drivers, I mean, we guided them for 3 years. When we did our Investor Day in November of last year, that was really meant as a 3 year guidance. And you've also seen there the relative sizes between them and the relative growth speed. And I think Bill in his prepared remarks Emphasize that we are, what did you say, very well on track, Bill, for all 6 of them. So I think the way you should look at this is that all 6 are very much intact and the relative contribution of them is in line with how we guided them at the Investor Day last November.

Speaker 2

There is no change. But what I think is important to say is that they are all on a very good track.

Speaker 4

Thanks, Kurt.

Operator

Thank you. One moment for our next question. And our next question coming from the line of Joe Sakai with Morgan Stanley. Your line is open.

Speaker 9

Great. Thank you. In your answer to your prior question, you said you were Going to be careful with sort of customers trying to build inventory, but there's also a clear message from your automotive customers That they do want to hold a larger amount of safety stock. Can you talk to that effort generally? Do you see that build having started yet?

Speaker 9

Where do you plan to allow them to have to hold more safety buffer and do you expect that to happen at the OEM level or at

Speaker 4

the Tier 1 level if that does happen? Thank you.

Speaker 2

Yes, Stacy. That is an important dynamic indeed. So In general, I'd say the OEMs try to leave that challenge with the Tier 1s. There might be exceptions here and there, but The more general direction is that the OEMs put this on the shoulders of the Tier 1s. Size of that is Varying.

Speaker 2

We see and hear about requests which are in the order of 3 months. We hear others which talk about 6 months of inventory. It is also not the same for each product. They categorize, I think, more into very single source, very Strategic products versus more commodity like products. So it has all sorts of variations, but I think first of all general message more with the Tier 1s than the OEMs.

Speaker 2

Has it started yet? No. The supply capability at least relative to NXP product, I mean, I can't make That comment for my peers, but for our product, no, it hasn't started yet. Any inventory builds, which accidentally might happen at Tier 1 at the moment is indeed more related to the Golden Screw problem, where it builds for a while and then it flushes through again when the Golden Screw product becomes available, but that's not associated with or because of the intended safety stocks. I believe that somewhere in the course of next year that will in a more methodical way I do indeed believe that towards 6 months might be a consensus many of them want to achieve, But again, only in the course of next year.

Speaker 9

Great. Thank you very much.

Operator

Thank you. One moment for our next question. Our next question coming from the line of Stacy Ruskow with Bernstein Research. Your line is open.

Speaker 10

Hi, guys. Thanks for taking my questions. The first one, Bill, I wanted to follow-up on a comment that you might have made In passing, I know you guys have talked about derisking Q3 backlog, but Bill you actually said that you derisked Q3 outlook. I'm actually wondering, did you actually reduce the revenue outlook that you gave, coincident with some of the cautions that you talked about? I'm not sure you did because it also sounds like you're supply constrained anyways, but was there any sort of reduction at all in your outlook given the macro You're seeing and if so like how much was it and which end markets?

Speaker 2

Yes. So Probably that is a matter of fact for especially the mobile market, where you saw that we actually guided sequentially a touchdown. Since we are not overly, but we are also exposed to the low end Android players in China, And I have a total paranoia to not build any inventory there. So I'd say there is probably indeed a risk adjustment on from the macro perspective relative to mobile in that particular part of our business. There at the same time in Auto and Industrial for the Q3, I can only repeat what I said earlier.

Speaker 2

We are sold out And the revenue capability is much more determined by our supply capability in the Q3. So it's a mixed picture where the majority is clearly continues to be supply constrained.

Speaker 4

Got it. Thank you. Let

Speaker 2

me take one more.

Speaker 4

Yes, please.

Speaker 2

The risk adjustment Also a longer term message, which is really related to the assessment of about 80% supply coverage against That is not just a statement for Q3. I mean, that is really a statement for the longer term period. I would go that far to say It includes very large parts of next year actually, where that judgment is done after risk adjustments. And you know risk adjustments are also when we get all the patterns say in automotive from automotive customers and we add them all up and then we What content increases should be, we know where the car production could possibly be next year. And then of course you see that All the different Tier 1s want to win market share.

Speaker 2

All the OEMs want to win market share against each other. And the sum of the parts is the bigger of what could be realistic. So then we make a risk adjustment to this because we know that the SAAR can only be at a certain size next year. So that's one of the elements which I would label, practically speaking, risk adjustments where we bring down What looks like an overwhelmingly huge backlog.

Speaker 10

Got it. That's super helpful. Thank you. For my follow-up, I wanted to repeat a question. Somebody else asked it, but I don't think you actually answered it.

Speaker 10

It was run the non cancelable, non returnable orders. We've seen these from other companies and it turns out in practice maybe they're not quite as non cancelable as they appeared. How non cancelable and non returnable are your NCEAN orders really?

Speaker 2

Well, indeed, sorry, I know that was part of an earlier question. I I missed speaking to it. Well, it's like with every contract. There is clearly a legal system in place. But in the end, of course, reasonable behavior will prevail.

Speaker 2

What I can tell you, however, is that so far, Every one of them has been fulfilled. I mean, there is no we don't see any in automotive and industrial, there is no push outs, there is no constellations. People want to have more product. Now how that looks at sometime in the future when maybe macro continues to change more Could be different, but fundamentally, we put that system in place in order to make sure that our customers are serious and think 2 times and 3 times about what level of orders they want to put on us. And mind you that in many markets, Different products from different customers go into one end product.

Speaker 2

So we have to make sure that there is a proper allocation between them. And Otherwise, the car company is only suffering in the end. I mean, if there is too much orders from 1 Tier 1 and the other one orders not enough, Then it doesn't help the car company. That's another reason why we are really trying to put NCR and ARS in place in order to hold people to the truth.

Speaker 3

Let me just add to what Kurt mentioned. What we said this year, our NC and Rs were larger than our long term commitments. Of those NCNRs, we can't service them all. We have started our process for 2023 NCNRs, and they are tracking to similar levels as well, which we won't be able to supply as we go forward.

Speaker 10

Got it. That's super helpful guys. Thank you so much.

Speaker 2

Olivia, do we have other questions?

Operator

Yes, our next question coming from the line of Matt Ramsay with Cowen. Your line is open.

Speaker 6

Yes, thank you very much. Good morning. Bill, I wanted to ask a question about OpEx in sort of the context of the macro environment that we're talking about here. You guys have with revenue growth and the gross margin expansion, I think growing gross profit, I don't know, it will be 75% or something like that from 2020% to 2022% and that's allowed for A lot of expansion of the operating expense while you're still getting leverage. And I guess the question is with inflationary pressures and wages and all those things, It seems like there's still some upward pressure in the OpEx line.

Speaker 6

And I just wanted to know what kind of levers you had to control that and what the priorities would be to control that if in fact the macro did turn and would you be committed to sort of holding the operating margin flat or is there a case where you're going to need to keep spending despite what might go on in the macro? I guess just puts and takes on OpEx would be helpful. Thanks.

Speaker 3

Sure. Thank you for your question. Again, we continue to do very well here as we are operating below the 23% long Term model. Q2, we finished at 21.9%, and that was slightly better than our guide. And I think we just guided 21.7%.

Speaker 3

And again, that primary increase from an absolute standpoint is really being driven by our new college graduates joining the company and Continuing R and D investments supporting our growth ambitions. Now if there is a downturn, what will we do? We have a plan for that. It's well defined. It's all around protecting our free cash flow.

Speaker 3

Our planned actions would potentially include reducing variable compensation, Reduce discretionary spending, reduce the non critical CapEx, will slow down Our non engineering hiring and also right our attrition runs around 10%, 12%. We would obviously not backfill all of those depending on how severe it gets. By all means, we will protect our R and D engine of the company, which I've said in the past as well as Kurt is the lifeblood of our growth. And then similar with optimizing our costs, you have to remember the last 2 years we've been optimizing toward material shipments To prevent customer line downs, we haven't been focused on our mix or optimizing of costs or yields or cycle time. So That's another level that lever that we have in our playbook to maintain our margins in our range that we shared during our Analyst Day.

Speaker 6

Got it. Thanks, Bill. Quick follow-up for Kurt. I was interested in your prepared script. I think you mentioned that the same Sort of ratio of your product portfolio still had 52 week lead times as was last quarter.

Speaker 6

We get a lot of investor questions about Maybe there's shortages of Part X, but there's inventory builds of Part Y and Part Z and things are out of balance. It doesn't seem like that's the case with NXP's I'd be interested if you could comment on that a bit further. Thanks.

Speaker 2

Yes, absolutely, Matt. I guess that really has to do with the mix of our end market So I would actually confirm that in mobile, we are probably moving away from But those technologies are badly needed in other markets which we are serving, which are heavily underserved, while the demand there continues to go up. So it is of course a puzzle where we Quickly try to redirect from where demand is softening. And again, that's especially the low end Android handsets and Some of the more consumer oriented products in China, which is little for us. I mean, the whole point is this is not that much for us.

Speaker 2

But that little where we have it, We move into other areas in auto and industrial where actually demand continues to go up such that in bottom line in the end, We unfortunately, and I really have to put it that way, we are still at a similar lead time pattern as we had indeed last quarter, which About 80% of the portfolio sits at 52 weeks plus lead time, but it is different product. So that's why I Totally understand and support your question. It is not exactly on the same products because it's moving, but in the mix it still stays at that level. Okay. Olivia, I think we'll move to the last question for the call today, please.

Operator

Certainly. And our last question coming from the line of Toshiya Har with Goldman Sachs.

Speaker 11

Hi, good morning. Thanks so much for taking the question. I was hoping you can speak to Trends that you're seeing in the China business, particularly around industrial and distribution. I think historically, It had been a fairly volatile part of your business, but clearly based on your overall industrial and IoT numbers, you seem to be doing really well. So Any sort of puts and takes around particularly around the lockdowns going into it coming out of it?

Speaker 11

Any comments would be super helpful.

Speaker 2

Yes. So first of all, relative to the lockdowns, I mean, we had indeed also risk adjusted our quarter 2 guidance, which had to do much more with supply than demand. That was about epoxy suppliers, lead frame suppliers and others. And as you can see from how we managed to make our actuals work, some of that exactly materialized. I mean, Indeed, we saw that.

Speaker 2

However, we see now since June Pretty significant and impactful stimulus programs by the China government, which are starting to take effect and that's both into the industrial as well as So there is a slight optimism, notwithstanding the risk of further lockdowns, of course, in China. But from a government stimulus program perspective, there is optimism both for the industrial as well as for the automotive markets in China for Q3 and for the second half of the year. I had I think mentioned it briefly in my prepared remarks, our Channel inventory is sitting still only at 1.6, which is very low. And mind you that The industrial business of NXP and with that especially in China is dominated by the distribution channel. So a lot of that is in China.

Speaker 2

And as you can see, it really hasn't moved up much. I think we had 1.5 the last two quarters, 1.6 before. So we are still hovering at that very low level, which is a month below our 2.5 target actually.

Speaker 11

Yes, that's super helpful. Thank you. And then as my quick follow-up, separate topic, but on the currency dynamics, Obviously, you've seen the dollar appreciate significantly relative to other currencies. And I recognize that Customers don't swap in and out components given long qualification cycles and whatnot. But as we think about the competitive And microcontrollers over the next couple of years, just given how strong the dollar is today, is that something that we should cognizant of and worried about as you compete with companies like STM and Renaissance or is that not really topics that we should be spending too much time Thank you.

Speaker 3

Yes. I'll take that one. Thank you for your question. NXP is a global company. We're U.

Speaker 3

S. Based. We're naturally hedged against the euro. So I'm not really too concerned about it.

Speaker 11

Thank you.

Speaker 2

All right. So I think that gets us to the end of the call. And let me just highlight once again, We feel we have operated well in the Q2 in a pretty turmoil environment. We are also very cognizant of the macro crosscurrents, which we also discussed quite a bit in this call. Yes, the outcome is that in the majority size of our revenues, which is the industrial and automotive markets, we continue to be sold out.

Speaker 2

We think the underlying secular growth trends, especially from content increases, both in industrial and automotive applications, are also providing a pretty safe landing going forward relative to demand. The one thing which we are very paranoid And very hard working on is indeed making sure that our inventories down the chain remain low. We think today they are low. We have evidence of this in Channel with 1.6 months and our whole focus day in, day out is to make sure that on the one hand we organize more supply, But on the other hand, we make sure that there is no excess inventory being built in the market down there. With that, I want to thank you all on behalf of NXP for today's Call and see and speak to you all soon.

Speaker 2

Thank you very much. Thank you.

Speaker 1

Thank you very much. This ends

Speaker 2

our call today. Thanks everyone. Bye now.

Operator

Ladies and gentlemen, this is our conference for today. Thank you for your participation. You may now disconnect. Good day.

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