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. Please be advised that today's conference may be recorded. I would now like to hand the conference over to your speaker host today, Jeff Palmer. Please go ahead, sir.

Thank you, Lydia. Good morning everyone. Welcome to NXP Semiconductors' second quarter 2022 earnings call. With me on the call today is Kurt Sievers, 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 are not limited to, statements regarding the continued impact of the COVID-19 pandemic on our business, the macroeconomic impact on specific end markets in which we operate, the sale of new and existing products and our expectations for the financial results for the third quarter of 2022. Please be reminded that 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, 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 second quarter 2022 earnings press release, which will be furnished to the SEC on Form K 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.

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 two performance. Our revenue was $37 million better than the mid-point of our guidance with automotive, 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 two revenue of $3.31 billion, an increase of 28% year-over-year. Our non-GAAP operating margin in quarter two was a record 36%, 400 basis points better than the year-ago period and about 30 basis points above the mid-point of our guidance. Our results reflect strong execution with better than guided operating leverage and profit flow through on the incrementally higher revenue on top of improved gross profit. Now let me turn to the specific trends in our focused end markets. In automotive, revenue was $1.71 billion, up 36% year-over-year near the high-end of guidance. In industrial and IoT, revenue was $713 million, up 25% year-on-year, better than our guidance. In mobile, revenue was $388 million, up 12% year-on-year in line with our guidance. And lastly, communication infrastructure and other revenue was $498 million, up 20% year-on-year in line with our guidance. Looking at the trends across our end markets, we are not naïve to believe NXP is immune from the clearly weakening macro environment. We are highly alert, and we review frequently and very closely several key indicators relative to the dynamics of customer demand versus supply, inventory per channel, per end market, and per geography. When we look at demand signals, we have a high level of confidence in the intermediate term outlook. This is especially true in terms of demand trends in the automotive and industrial markets, which account for the majority of our total revenue. While there is well-documented weakness in the low-end Android handset markets, it is important to note that our mobile business is more biased towards the premium-tier members. 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 automotive and industrial customer base. Relative to long-term committed customer demand, a large percentage of our major customers continue to firmly desire our supply assurance commitments, which are facilitated by placing non-cancelable non-returnable orders with us throughout 2023. Currently, the level of NCNR orders into 2023 is greater than our ability to service. 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 limestone, thus avoiding excess or stagnant inventory build-up. 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 two on a dollar basis consistent with orders placed with suppliers and internal built plans. The primary area of increase is in raw material and work-in-progress in order to fulfill firm customer commitments in the future, especially in quarter three. On a days basis, DIO was 94, an increase of five 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 two, 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 seventh consecutive quarter of an exceedingly tight supply situation in the channel. Finally, let me speak to our ability to service customer requirements. Lead times continue to be extended with more than 80% of the whole 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 than the first on an absolute dollar basis. Now let me turn to our expectations for quarter three. We are guiding revenue at $3.425 billion, up about 20% versus the third quarter of 2021 within a range of up 17% to up 22% year-on-year. From a sequential perspective, this represents growth of about 3% at the mid-point versus the prior quarter. At the mid-point, we anticipate the following trends in our business. Automotive is expected to be up in the low 20% range versus quarter three 2021 and up in the mid single-digit range versus quarter two 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 two 2022. Mobile is expected to be up about 10% year-on-year and down in the low single-digit range versus quarter two 2022. 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 cross currents 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. However, we are staying alert 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 call over to you, Bill, for a review of our financial performance.

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 million above the mid-point of our guidance range and both non-GAAP gross profit and non-GAAP operating profit were above the mid-point of our guidance. Now moving to the details of Q2, total revenue was $3.31 billion, up 28% year-on-year and above the mid-point of our guidance range. We generated $1.92 billion in non-GAAP gross profit and reported a non-GAAP gross margin of 57.8%, which is up 170 basis points year-on-year and both above the mid-point of the guidance range as a result of higher revenue and positive product mix. Total non-GAAP operating expenses were $724 million, or 21.9%, up $98 million year-on-year, and up $36 million 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 $1.19 billion and non-GAAP operating margin was 36%, up 400 basis points year-on-year and both above the mid-point of the guidance range. Non-GAAP interest expense was $97 million, with cash taxes for ongoing operations of $150 million or approximately 13.7% effective cash tax rate and non-controlling interest was $13 million. Stock-based compensation, which is not included in our non-GAAP earnings, was $89 million. Now I would like to turn to the changes in our cash and debt. Our total debt at the end of Q1 was $11.16 billion, up $587 million sequentially as we issued $1.5 billion of new debt and simultaneously retired early the $900 million of debt, which was due in June of 2023. Our ending cash position was $3.55 billion, up $862 million sequentially due to a combination of the previously mentioned financing, CapEx investments, and capital returns during Q2. The resulting net debt was $7.62 billion, and we exited the quarter with a trailing 12-month adjusted EBITDA of $4.96 billion. Our ratio of net debt to trailing 12-month adjusted EBITDA at the end of Q2 was 1.5 times, and our 12-month adjusted EBITDA interest coverage was 12.7 times. 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. 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 1.6 months, well below our long-term target. Days receivable were 27 days flat sequentially, and days payable were 94 days, 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. Cash flow from operations was $819 million and net CapEx was $268 million, or 8.1% of revenue resulting in non-GAAP free cash flow of $551 million, or 17% of revenue. During Q2, we paid $222 million 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 Kurt mentioned, we anticipate revenue to be about $3.425 billion plus or minus about $75 million at the mid-point. This is up 20% year-on-year and about 3% sequentially. We expect non-GAAP gross margin to be about 57.8% plus or minus 50 basis points. Operating expenses are expected to be about $743 million plus or minus about $10 million, 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% at the mid-point. We estimate non-GAAP financial expense to be about $95 million and anticipate cash tax related to ongoing operations to be about $160 million or about a 14% effective cash tax rate consistent with our communicated model. Non-controlling interest should be about $13 million. For Q3, we suggest that for modeling purposes, you use an average share count of 265 million shares. Finally, I have a few closing comments I would like to make. First, as Kurt mentioned in his prepared remarks, we have attempted to de-risk our Q3 outlook given the combination of the uncertain macroeconomic environment and well documented 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 six 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. Lastly, our people. We are very proud of 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 at our employees' incredible dedication and resilience. For powering through these extremely tough times, our results are a testament to their hard work. With that, thank you and I'll now turn it back over to the operator for questions.

Thank you. One moment for our first question. Now, first question coming from the line of William Stein from Truist. Your line is open.

Great. Thanks so much for taking my questions and congratulations on the strong execution. My first question relates to your reference to risk-adjusted backlog. Bill, you've 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.

Yes, thanks. Good morning Bill. What I try to convey is indeed, first and foremost, that for the foreseeable period ahead of us we are actually only covered with 80% with our supply against true demand which we see. And when I say true demand then that comes back to the risk adjustment. For good reasons, we have never revealed the size of our backlog through the past quarters, because I think I have always been clear that we’ve always believed inside the huge backlog there might be double orders which is just normally human behavior in times of slowness. 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 to that knowledge to try and actually risk adjust that backlog in order to come to a number which is mainly more meaningful. I just want to emphasize after doing that, Bill, 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, that’s why we risk adjusted it, and that is different in each of the markets we serve. The result of it leads, in the foreseeable future, to 80% coverage of that adjusted demand.

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

Yes, clearly we absolutely stick to our hybrid manufacturing model. We continue to believe, and I think the results of the past six to eight 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. 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 seamless logic processes. Especially when it comes to 300 millimeter and when it is below 90 nanometers. 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 and 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. By moving out more of the CMOS to our foundry partners, we are creating more space internally in our existing facilities to serve the increased and ever-growing needs for these proprietary technologies going forward. 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 pillars in that market over the last six quarters.

Great. Thank you.

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.

Hi guys. Thanks for letting me ask a question. Kurt, I wanted to dive a little bit into the potential disconnect of you guys doing everything you can to manage the backlog, scrub it, appreciate what's going on in macro, but yet the guidance seems fine in the quarter. And you said you are 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. But last quarter you said you thought you would grow sequentially in the third and fourth quarter. So does that growth in the second half imply that you would still believe you will grow sequentially in the fourth quarter?

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 cross currents 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. 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 turmoiled 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 three. I don't have a crystal ball for quarter four, 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. So I cannot really make a firm assessment on what mobile and other consumer markets will do into the fourth quarter. 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.

Thanks for that color, Kurt. I guess my follow-up one for Bill, I noticed this was the first quarter in, I think, a 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?

Yes. First off, thanks Ross for your question. And I wouldn't read too much into it. First off, there is no change to our capital return policy. I stated 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 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 billion from our board. At the end of the year, we do expect to return to be at least a 100% or higher, consistent with our stated policy.

Thank you.

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

Yes, good morning. Thank you for taking the question. I guess first question, Kurt, I was hoping you could speak to how you are thinking about the overall state of the auto industry. This morning, some auto manufacturers missed, but it looks like their second half prior outlook was perhaps a bit aggressive. At this same time you have OEMs that are waiting for those golden screws and hopefully we'll get those. 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? And when do you think we can normalize in the auto supply-demand side of things? Is that in 2023 or might that be longer?

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 million cars this year. 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. Especially in the second quarter, 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 two car production will grow quite nicely over the first half, finally. 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 depth before, the bigger factor for us, however, certainly remains the content increase. 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 XUVs. 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 XUV production. And again, mind you that with our battery management, inverter control, and many microprocessors and microcontrollers associated with XUVs and an overall semi contact 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. 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.

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 eight-inch 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?

Well, first off of your question, yes. Second half, I will not comment on, 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 four 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 are various different ways of achieving this, C.J. So it don't get locked down into the idea with TSM. There are all sorts of options, which we can do including, but again, not exclusively, but also including the opportunities which are being provided by the trip techs in Europe and the U.S. where the majority of our facilities are.

Very helpful. Thank you.

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

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 defensive will the pricing strength be in that kind of market?

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. We do continue to see our input costs 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 soft again, I believe that especially in the automotive environment where there is a supply-demand imbalance is heading into next year, there is a chance that pricing continues to go up into next year again. I think I said it a number of times, we have a very transparent policy here that we are increasing our prices to the customers in line with the input cost increases, which we are experiencing in order to protect our gross margin percentages. So on that side, from a pricing perspective, even with flat car production or maybe, 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, in a way I answered it, given content increases, surpassing the impact or outbalancing the impact of the SAR so much, I unfortunately believe that even in a soft reduction of SAR next year, we would continue to see in many technologies an imbalance between supply and demand next year.

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

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 would just like to remind everyone that we will focus on growing our top line or 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 or every year. And we'll revisit this during our normal three-year long-term model that we provide, or if there's any material change to our business model. So no change, we feel very confident to run, like I mentioned, last call, toward our high end of the model for the rest of the year.

Thank you.

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

Hey guys, thanks for taking my question. I appreciate your commentary with respect to how you de-risked in your third quarter guide the different macro issues and whatnot. But want to ask conversely, what can go right in the last two plus months of the quarter to maybe hit the high end of the expectation as it relates to COVID mitigation in China, kidney issues, additional supply and whatnot.

Well Gary, I mean, we give a guidance with a midpoint and a 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 $3,425, 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 a guidance for the next quarter is really driven by what we hear from our customers. I mean, it's such a short period of time in a way that it is really just tuned into the short-term customer confirmed orders and our supply capability. The way I would put it Q3 upsides are probably more than anything dominated by our supply capability since we are sold out for the quarter.

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

Well, the six accelerated growth drivers. I mean, we guided them for three years. When we did our Investor Day in November of last year, that was really meant to be a three-year guidance. And you've also seen there the relative sizes between them and the relative growth speed. I think, Bill, in his prepared remarks emphasized that we are well on track for all six of them. So I think the way you should look at this is that all six are very much intact, and the relative contribution of them is in line with how we guided them at the Invested Day last November. There is no change, but what I think is important to say is that they're all on a very good track.

Thank you, Kurt.

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

Great. Thank you. You answered 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? You know, 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 the Tier 1 level if that does happen? Thank you.

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. The size of that is varying. We see and hear about requests, which are in the order of three months. We hear others which talk about six 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, the general message is more with the Tier 1s than the OEMs. 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 build that might accidentally happen at Tier 1s 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 someone in the course of next year that will, Bill, in a more methodical way, start to be built. I do indeed believe that towards six months might be a consensus many of them want to achieve, but again only in the course of next year.

Great. Thank you very much.

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

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 had talked about the risk in Q3 backlog, but Bill, you actually said that you de-risk 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 your supply constrained anyways, but was there any sort of reduction at all in your outlook given the macros that you're seeing, and if so like how much was it and which end markets?

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. I have a total paranoia to not build any inventory there. So, I'd say there is probably indeed a risk adjustment from the macro perspective relative to mobile in that particular part of our business. There at the same time in the automotive and industrial for the third quarter, I can only repeat what I said earlier. We are sold out and the revenue capability is much more detail-minded by our supply capability in the third quarter. So it's a mixed picture where the maturity is clearly continues to be supply constrained.

Got it. Thank you.

The risk adjustment – let me take one more.

Yes, go ahead.

The risk adjustment was also a longer-term message which is really related to the assessment of about 80% supply coverage against demand. 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 risk adjustments are also when we get order patterns say in automotive from automotive customers, and we add them all up. Then we know what content increases should be. We know where the car production could possibly be next year. Of course, you see that all the different Tier 1s want to win market share. All the OEMs want to win market share against each other. 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 SAR can only be at a certain size next year. So that's one of the elements that I would label practically speaking risk adjustments, where we bring down what looks like overwhelmingly huge backlog.

Got it. That's super helpful. Thank you. For my follow-up, I wanted to repeat a question somebody else asked, but I don't think you actually answered it. 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 non-returnable are your seeing orders really?

Well, indeed. Sorry, I know that most part of an earlier question, I think 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. 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 industrial. There is no pushout, there is no cancellation. People want to have more products. Now, how that looks at some time 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. Think two times and three 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. So we have to make sure that there is a proper allocation between them; otherwise, the car company is only suffering in the end. I mean, if there are too many orders from one 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 NCNR in place in order to hold people to the truth.

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

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

Lydia, do we have other questions?

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

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 seen significant revenue growth and gross margin expansion; I think growing gross profit around 75% or something like that from 2020 to 2022. And that's allowed for a lot of expansion of 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. 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.

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%, which was slightly better than our guide, and I think we just guided 21.7%. That primary increase from an absolute standpoint is really being driven by our new college graduates joining the company and continuing R&D investment supporting our growth ambitions. Now, if there is a downturn, what will we do? We have a plan for that. It's well defined, and it's all around protecting our free cash flow. Our plan actions would potentially include reducing variable compensation, reduced discretionary spending, reducing non-critical CapEx, we'll slow down our non-engineering hiring, and also right, our attrition runs around 10% to 12%, we would obviously not backfill all of those depending on how severe it gets. But at all means we will protect our R&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 two years we've been optimizing toward material shipments to prevent customer line downs, we haven't been focused on our mix or optimizing costs, yields, or cycle times. So that's another level that we have in our playbook to maintain our margins in our range that we shared during our Analyst Day.

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. 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 business. I'd be interested if you could comment on that a bit further? Thanks.

Yes, absolutely. Matt, I guess that really has to do with the mix of our end market exposure. So I would actually confirm that in mobile, we are probably moving away from supply constraints 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, that the whole point is this is not that much for us, but that little where we have it, we move it to other areas in auto and industrial, we are actually demand continues to go up such that in bottom line we be 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 did about 80% of the portfolio since 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. Lydia, I think we'll move to the last question for the call today, please.

Certainly. And our last question coming from the line of Toshiya Hari with Goldman Sachs. Your line is open.

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, any comments would be super helpful?

Yes. So first of all, relative to the lockdowns, I mean, we had indeed also risk-adjusted our quarter two guidance, which had to do much more with supply than demand that was about epoxy suppliers, leadframe suppliers, and others. As you can see from how we managed to make our actuals work, some of that exactly materialized, I mean, indeed we sold it, 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 into the automotive market. 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, and as you can see it, 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.

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 landscape and microcontrollers over the next couple of years, just given how strong the dollar is today, is that something that we should be cognizant of and worried about as you compete with companies like STM and Renaissance, or is that not really a topic that we should be spending too much time on? Thank you.

Yes. I'll take that one. Thank you for your question. NXP is a global company. We're U.S.-based, we're naturally hedged against the Euro. So I'm not really too concerned about it. 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 second quarter in a pretty turbulent environment. We are also very cognizant of the macro cross currents, which we also discussed quite a bit in this call. Yet the outcome is that in the majority size of our revenues which is the industrial and automotive markets, we continue to be sold out. 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 inventory down the chain remains low. We think today they are low. We have evidence of this in the channel with 1.6 months, and our whole focus day-in and 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. Thank you very much. Thank you.

Thank you very much. This ends our call today. Thanks to everyone. Bye now.

Ladies and gentlemen, this conference has concluded. Thank you for your participation. You may now disconnect. Good day.