NXP Semiconductors N.V. (NASDAQ:NXPI) Morgan Stanley Technology, Media & Telecom Conference March 5, 2024 11:45 AM ET

Company Participants

Jeff Palmer – Director, IR

Conference Call Participants

Joseph Moore – Morgan Stanley

Joseph Moore

Good. All right. Thank you, everybody. Welcome back. I’m Joe Moore, Morgan Stanley Semiconductor Research. Very happy to have with us today, Jeff Palmer, our Director of Investor Relations for NXP. So Jeff, I think maybe if you could just start off with a little bit of an overview of the company’s priorities in the year ahead. And then we’ll go into direct Q&A.

Jeff Palmer

Yes. I think this is a little loud excuse me. I think for the year ahead, the way we’re looking at, is how we navigate. What clearly looks like a trough in – our end markets in a very controlled manner. Over the last couple of years, we’ve managed our distribution channel very, very tightly, very cautiously. And over the last couple of quarters, we started to see a little bit of maybe excess inventory at some of the Tier 1s in automotive. And so we want to navigate through that, and really navigate a soft landing into the first half.

Question-and-Answer Session

Q – Joseph Moore

Okay. Great. I can speak more quietly, I guess I’m scaring myself. Can you talk to the gross margin and operating margin trajectory of the company? You’ve executed really well there. You’re ahead of the longer-term targets that you’ve set? How are you thinking about that going forward?

Jeff Palmer

I think, the thing people have to realize, is over the last decade or so, we have flipped the fixed versus variable cost structure of the company. So when I started with the company, 13 years ago, our fixed costs were about 70%, and our variable costs were 30%. We flipped that 180 degrees now. And that goes hand-in-hand with the fact that, we’ve increase the amount of wafers we buy from foundries.

We’re now buying 60% of all of our wafers from foundries. That’s all variable costs. We run our own back end, where we own about 85% of our capacity. So that’s the first thing, is that the cost structure has changed. Secondly, for those of you who followed the company for a number of years, if you’ll remember back kind of 2019 and before, we struggled to get to about 55% gross margin.

And that was, because we couldn’t get the revenue over $10 billion. The business is was kind of structured and organized, to at least pour $10 billion of revenue through it. Once you get above that, you get great – fall through.

Joseph Moore

Great. And can you talk a little bit, and I’ll get into some of the end markets, but the role of pricing, one of the things I found really helpful is you guys give good data around this, and you talk about what like-for-like pricing has done. And that’s a key debate now, for the sort of analog microcontroller businesses. Going forward, can you talk to what you’re seeing on the prices?

Jeff Palmer

So the reason, we raised prices over the last couple of years, and maybe just, to level set everyone, in 2021, prices were up 2%. In 2022, they were up 14%. And then just this last year in ’23, they were up 8%. And the reason prices went up, is our input costs went up. And so, we made a decision that we would only pass along, the gross step amount of our input cost to our customers.

So we didn’t pad our margins. And so, our current thinking is that maybe we get into ’25, we might be at a place where we may be able to offer some of our larger customers, low single-digit like-for-like pricing, but off the elevated base. We don’t agree with the thinking that pricing has got to revert back to where it was in 2019. We just don’t see any reason why that would occur.

Joseph Moore

Okay. That’s very helpful. And then last big picture question. Manufacturing footprint, is going to be a debate here. TI, in a very aggressively investing in capacity in the U.S. As you said, you’re more of a variable cost structure. But you’ve also taken with your own fabs, a very geographically diversified planning process, where you have manufacturing in each region. Can you just talk to that, and talk to how much your customers prioritize that?

Jeff Palmer

Sure. So, we would call our model a hybrid model, not a fab-light model. So we build about 40% of all of our wafers in-house. We have about four fully owned 8-inch factories, one in the Netherlands, two in Austin, Texas, one in Arizona. And then we have a joint venture with TSMC in Singapore, which we’re the 62% owner. So it consolidates into our financials. All these factories are 8-inch.

They run proprietary mixed-signal products, all above 90 nanometer. We pushed all bulk CMOS out of our factories, over the last couple of years, and it’s all in the foundry network. We would say that our own factories give us a very distributed – geographically distributed base. And then we’re partnered with people like TSMC, who we have a joint venture in [ Dresden ] with.

We have going to use their factory in Arizona for the 5-nanometer process, and then we build in Taiwan and other parts of the world. Then there’s GlobalFoundries, who also is very geographically diverse. So, we think that our model works well for us.

Joseph Moore

Okay. Great. Thank you. So maybe looking at some of the end markets, starting with automotive, which is your biggest market. You’re looking at a year-on-year decline for the first time in March. And you talked about a soft landing. How do you feel like you navigate that? And can you elaborate on how you guys have – I feel like you guys have managed this very tightly. You saw weakness maybe when others didn’t. So your peak to trough, is probably a little different than the company?

Jeff Palmer

Yes, we would agree. I think our peak to trough is much different than some of our peers. You have to remember that about just over 50% of our business goes through the channel, which we manage completely. We manage what gets shipped in. We manage what the inventory is there, and we get full visibility, to where it goes to from a sales out perspective. We get that data daily. We review it weekly as a management team.

So, I think we’ve managed our channel very well. The other 45, or so percent of the business, which is direct and is very much automotive and large industrial customers. We started to sense in Q2, if you go back and read our transcripts that, there were some inventory building at some European Tier 1s that, then expanded to some North American Tier 1s. And we do believe that the auto Tier 1s are a bit over inventory.

We think, it will take us through around the first half of 2024, to enable them to burn off that inventory. And you might say, well, how do we enable that? Well, we had non-cancelable, non-returnable orders with these Tier 1s. They contact us and said, look, if you force us to take this inventory, we’re just going to put it on the shelf. We made the decision that wasn’t going to help anybody.

So, we’ve found business accommodations with those customers, to allow them to kind of the breathing room, if you will, to burn off that excess inventory. And we felt that’s the right thing to do. That will give us a little less growth in the short-term. You saw that in second half of ’23.

As you mentioned, we’ve got a down quarter here in Q1. But we think that’s the right thing. It sets us up very cleanly for – what we believe is the beginning kind of, the next cycle of our industry sometime in the second half of the year.

Joseph Moore

And isn’t there an argument, I mean, given how severe the automotive shortages were a couple of years ago that, your customers would continue to operate in a higher inventory, having a safety stock. And do you think that’s the case, and we’re seeing a burn off relative to that? Or just how should we think about that?

Jeff Palmer

I think you’re right, Joe. I think the OEMs continue to remember the pain they went through, for a couple of years. And I think, there is a lot of tension between the OEMs and the Tier 1s, as to how much inventory should actually be held by the Tier 1s. But there’s not a lot of – there’s not a lot of levers the OEMs have on existing running business, to tell the Tier 1s, you must hold this much inventory. So there is some concern that, if the Tier 1s go too far, correct too far – to burning off inventory, they’re just going to sow the seeds for another shortage situation in the out years.

Joseph Moore

Yes. I mean the math seems fairly straightforward that internal combustion vehicle maybe $400 worth of components, most of which is long tail stuff that, you just said is staying – the price is staying the same. It seems like the math would say, hold more inventory to avoid these shortage situations?

Jeff Palmer

We would agree with that. I think the challenge is a lot of the Tier 1s operate on very tight working capital metrics and their challenges were – they were enabled, or couldn’t renegotiate their business conditions with the OEMs directly.

Joseph Moore

Great. And one of the drivers that really matters for you guys, not just idiosyncratically, but for the overall automotive ecosystem, is the migration to EVs. I feel like sentiment has shifted a little bit more negatively from investors on EVs, our auto team is really negative on EVs, just for what it’s worth. And we’re trying to partial all that out. Can you talk about how you think about that? Is this a movement that just continues, maybe not linearly, but that we’re going to move away from internal combustion towards EVs over time?

Jeff Palmer

It’s a long-term EVs is the future and various types of EVs, whether it’s plug-in hybrids, or full electrics. I think the angst about the transition to EV is very much a U.S. Wall Street fixation, if you ask me. If we look at how the businesses are trending in China, and other parts of the world, it’s continued to grow. We continue to see 2024 being a year where EVs will make up maybe about 40% of the total global SAAR.

That’s still 25% year-on-year growth. It’s slowing down a little bit, but it’s not going negative. And the thing that was very interesting for us, when we laid out our growth drivers in ’21 was we had a view of what EVs would do for us, from a powertrain perspective, primarily battery management systems inverter control.

What we didn’t fully contemplate was the pull-through on the rest of the portfolio. More safety features, more driver comfort features, and just higher electronic content that EVs are pulling along. And so, that’s been a very nice positive trend for us.

Joseph Moore

And you mentioned the role of China. I feel like the deceleration is kind of a U.S.-centric viewpoint a little bit, because China does continue to invest very aggressively in these technologies?

Jeff Palmer

That’s how we see they continue, to invest very aggressively and a lot of the large Chinese NAV players, are looking to tap into export growth, to drive their business.

Joseph Moore

Okay. Great. Some of your specific drivers that you’ve talked about maybe starting with battery management on the EV topic. That is a very compelling opportunity, obviously, doing that well, enhances the range of the car, which is one of the most important elements. How are you doing there? Your analog devices talks about that market as well it’s…?

Jeff Palmer

Yes. I’d say it is – currently, it is a duopoly. ADI is larger than NXP today through their acquisition of Maxim and Linear great company. I think the difference between our offering and ADI’s offering is our offering is more of a system solution. So it’s a combination of analog devices that, sit out on the battery pack, connected with the back-end processor that we run load balancing software on that it monitors the health of the battery cell, monitors and manages the discharge in charging rates.

And so it’s more of a system solution. That business, we had expected to grow from about $200 million in ’21, to about $400 million in ’24. And we’re above that growth rate that kind of should value growth rate today.

Joseph Moore

Okay. And it’s not one of your Analyst Day drivers, but you just alluded to it. As you move to EVs, you look at the invention of Tesla, they sort of rethought the whole ecosystem of the car, and there were different. MCU accounts and different things. Are you seeing that elsewhere as well? And is that – you seem to have pretty good capability in like low-power MCUs. Stuff like that should help you?

Jeff Palmer

Yes, what we’re seeing is, if you think about the current architecture today of a car, it is a flat point-to-point architecture. And as more data comes into the car, more data movements around the car, that architecture, it is not extensive. And so a lot of the OEMs, this is an OEM-driven trend, not Tier 1, is to build more of a kind of a processing hierarchy in the car. And think of it from the kind of the top to the bottom.

At the top, you’ll have a vehicle computer, which is, maybe think of that as a gateway type of device, manage the input and output of data into the car. That gateway device would then manage multiple domains around the car. I think of domains as logical representations to different parts of the car, body and comfort, in-vehicle networking, e-cockpit, safety, things like that.

Those domain processors, then would manage different logical, zonal processors and zonal processes, are much more physical, logical representations. They aggregate data together, so that they can lower the wiring harness of the car. And the zonal processes then would manage edge node microcontrollers, things that, microcontroller that goes into the window lift, or your seat recline, what you have.

Our family of S32 processors enables the customers to adopt this technology, and have a common software stack, from the very high end all the way down to the edge. And we’ve done very, very well so far with that business. Early ramps of the S32 family, started at about $300 million in ’21. And we expect it to be about $600 million, by the end of ’24. We’re right on track.

Design win rates, which we don’t like to disclose, because it’s hard to just, talk about those type of things. The highest they’ve ever been in the history of the company, the last several years.

Joseph Moore

And does that sort of shift the competition away from like an MCU type of domain to people like Qualcomm?

Jeff Palmer

Well, I think what it does is, it’s not just an MCU business. So, the vehicle computers, these are NPUs. Those are more powerful multi-core 5-nanometer products. The domain processors are 16-nanometer MPUs. The zonals, can be a range of either microcontrollers or MPUs and then you have the edge nodes, MCUs. And so, we think we’re uniquely positioned to offer that full stack, to enable processing fabric, if you own the car.

Joseph Moore

Yes. Yes. And then on the – more traditional MCU business, which is a lot of your revenue, we’ve sort of heard these comments. I think one OEM talked about reducing the number of microprocessor families in a car by like 90%, which is sort of remarkable. That could be a very good trend for you guys, if you’re the beneficiary of that. Can you talk about that?

Jeff Palmer

Well, I think what you’re alluding to, Joe, is during the supply crunch, a number of the OEMs realized, because the way the design awards have been historically run, or the Tier 1s would award multiple different microcontrollers to different companies all over the industry and the OEMs that end up with a mishmash of different architectures that weren’t incompatible. So how do you write a software stack that, can navigate those different architectures.

And so, you do see a lot of the OEMs saying, look, we want to reduce the number of vendors that we work with. We want to build more of this fabric hierarchy. And because at the end of the day, the OEMs want to develop software that gives them life cycle management of the car. The car goes off the lot, they want to have at least enough headroom, to add features to the car after you leave the lot.

Joseph Moore

Great. And then the third growth driver you talked about in auto is radar. Can you give us an update on how you’re doing there?

Jeff Palmer

Yes. So on radar, we’re a market leader of 77 gigahertz radar. Again, it’s a system solution where as a transceiver, a back-end processing engine and Ethernet interconnectivity and a PMIC with it, that’s our complete solution. We’ve got about 45% – almost 50% market share of the 77 gigahertz radar market. We thought that business would grow from about $600 million in ’21, to about $1.2 billion in ’24.

We took a little bit of a pause in ’23, as a result of some of the inventory we talked about. This is a very concentrated buying market. There’s only a few Tier 1s, who actually buy those systems. And so, we’ve given them a little bit of a breathing room, to burn off some excess inventory, but we feel very confident in the long-term growth trends of radar.

Joseph Moore

Great. So overall, kind of wrapping up autos, I mean, you’re going through a little bit of a correction now. You feel good about that longer term kind of as you work through, those issues. And then, Kurt made the comments on the call, like I think we asked about peak the trough and he said, that’s not the right way to look at it, because we did a much better job of kind of minimizing the peakiness of that peak. So it seems like that’s a key differentiator for you guys relative?

Jeff Palmer

Well, I think if you look at last year alone, where prices were up 8%, but we only grew just under 1%, which means volumes were down about 7% right? And clearly, last year, you had global production, auto production of about 9%, and we didn’t grow greater than 5% in the second half. The math would indicate that we’re undershipping end demand.

Joseph Moore

Yes. Okay. It is interesting, because you have this wide variance of opinions that semiconductor companies have about autos in 2024 and yet the growth was actually pretty narrow range in Q4, and you were at the lower end of that, speaking to what you’re saying, is that there was some conservatism. But you have a company – one of your competitors has been vocally negative that, of course, automotive will correct, and they were up like 10% year-on-year in Q4, like they’re all seeing it?

Jeff Palmer

I think one thing that Kurt, our CEO has tried to really communicate, is each of our end markets that we participate in are cyclical. We’re not saying it’s a non-cyclical – they are cyclical, but they’re not synchronous, right? The mobile handset market is different from a cycle perspective to the auto market. We think we are going through a bit of a soft landing in autos, but we do think that long-term, the growth rate and the content growth rate, of autos is something is very attractive, and something we’re very focused on.

Joseph Moore

Okay. Great. Can you talk about trends in the industrial market? And again, it’s an area where you saw weakness maybe early, kind of work your way through it? Where are we in that process?

Jeff Palmer

Yes. So industrial and IoT is about 20% of our total company revenue. And while, we don’t disclose this in our filings, about 60% of that is, what we would call core industrial. About 40% of that is, what we would call consumer IoT. Consumer IoT ranges from wearables all the way to smart home type devices. And the core industrial range is primarily to factory automation, building automation and some healthcare.

Those are the kind of the end submarkets, if you will. We did see some very disturbing trends coming out of ’22 into early ’23. We took a very cautious look. That industrial and IoT business is about 80% through the channel. And so, it was something we were able to control very much with our own capabilities.

And so, we really think we took our trough in that business in Q1 and the first part of ’23. It has started to improve incrementally off that, lower base, but it’s not back to where it needs to be.

Joseph Moore

Yes. I mean this looks like the most severe inventory correction in industrial that I think we’ve ever seen in the sense of, because demand is okay. It’s not great, but it’s like we’re in a PMI 50 type of environment, as opposed to 2001, 2009, where we saw these economic meltdown?

Jeff Palmer

And I’d say I think most industrial customers are serviced through the distribution channel for all of our peers, right? It’s a very, very long tail business, tens of thousands of customers. It’s more efficient in many ways other than our friends in Dallas to direct – to manage those type of customers. And so for NXP, I mean, we’re not saying we’re smartest guys in the neighborhood, but we do think we took a very heavy hand, on how we would manage the channel.

And we did forgo some revenue early on, I mean, it was very easy for us to ship product into the channel. Our target in the channel, is to run about two and a half months. We’ve been running at about one and a half months – since mid-2022. So that’s about a $500 million delta. We’re using our balance sheet, to kind of buffer that material. And as we see demand come in from the channel, we can quickly turn it, and see sales out.

Joseph Moore

Okay. Great. Maybe you could talk about – I know it’s not a lower priority market for you guys, but the mobile market, smartphone market what are your prospects there are you seeing?

Jeff Palmer

So we’re a niche player in mobile. Let’s be real upfront, we’re 12%, 13% of total revenue. What we do in mobile is we provide a secure mobile solutions. And those solutions are if you use Samsung Pay or Google Pay or Apple Pay, you’ve used our technology. That kind of security capability has also allowed us to do things, like introduce ultra-wideband solutions, which is an RF device, but lays off the security in the mobile wallet.

We’ve introduced other type of eSIM technologies into the mobile wallet as well, for network access and personalization. We saw the Android market be very weak in the first half of ’23, like everyone. We think we’ve worked through those inventory corrections, and we’re seeing more of a kind of a pre-COVID seasonality type of trends in that market. But normally down in Q1, and it’s usually weaker in Q2, as well, and then rebounded in Q3 and Q4.

Joseph Moore

Okay. Great. So maybe you could talk a little bit about your uses of cash in this environment. I mean, you’ve had so far a very much better than peer kind of results. I think, largely due to how you’ve managed some of the automotive issues may be hitting later. You have very good cash flow. What are the priorities there between dividends?

Jeff Palmer

So, our capital allocation strategy, is actually very simple. Our goal is to return all excess free cash flow to our owners. We have one of two major methods to do so. We have a dividend, and our goal is to have a 25% cash flow from operations payout ratio. And we’re a little above that in Q4, but that’s about the target we want to run at. We view the dividend like debt.

So you never want to violate it and it will grow as cash flow from ops grows. The other opportunity, is to buy our shares in the open market. And our only real governor there on buying the shares is, so long as our leverage ratio, net debt to trailing 12-month adjusted EBITDA is two times, or below. We can be in the market where we would like to. That’s our model.

Joseph Moore

Okay. Let me – I have a couple of other questions. Let me see if we have any questions from the audience first. Maybe if you could talk a little bit, one of the debates that we hear is about Chinese competition, given that the EV market, is so prevalent in China, and that China is building a lot of fabs for – and hasn’t really talked about what they’re going to put in those fabs. How do you guys – I put you guys in a higher tier of defensibility that you probably don’t have to worry about that, but just how do you think about that part of the market?

Jeff Palmer

So if you think about China in two halves of a coin. First half, you mentioned the manufacturing. They’re clearly building out a lot of capacity, a lot of 300-millimeter fabs. I’d say a lot of that capacity is going towards power discretes, for the electric vehicle market, which we don’t participate in. But there is a number of mixed signal and bulk CMOS fabs in China.

We currently today don’t do any manufacturing in Mainland China today, but a lot of our customers in China have asked us for a manufacturing strategy, where we’ll build in China. They don’t want us to design there, but they want to have manufacturing security, just like the U.S., just like Europe does. So, we’ve engaged with TSMC, our major foundry partner. We will auto qualify, they have a 300-millimeter factory in Nanjing.

That engagement to auto qualify that has already kind of translate the station. We’re in process on that. That’s for 16 and 28-nanometer products. We also have a long history with SMIC in China, but that’s been primarily for our mobile and our consumer IoT business. We are engaging with SMIC, to auto qualify their lines also. And then, we’re also out hunting for a third 300-millimeter mixed-signal factory partner.

So once that’s done in about a year, we’ll be able to founder wafers in China for Chinese customers, that’s front end. On the back end, we own a large factory, a back-end manufacturing factory in Tianjin. We will slowly start to rotate rest of world products out of that back end, and make that more of a Chinese-only back-end factory. And so, within a year or so, we’ll be able to have a full front-end, back-end manufacturing footprint in China. That’s kind of on the manufacturing side.

On the socket design side, we fully believe that over the next decade, you will see more Chinese indigenous semiconductor companies. It would be naive to say you wouldn’t. But currently today and for the foreseeable future, we still compete with the same folks we compete with in Europe and North America, the TI, ADI, ST, Infineon. It’s the same with classic characters.

We do know that there are some smaller start-up microcontroller players in China, mostly at the consumer side, mostly at the low end, but we’ve not yet seen it come up into the automotive market. We are aware of some, what I’ll call, catalog, analog companies starting up in China, not really our valley with as much, but over time, our view is our day-to-day requirement is to compete effectively. As long as the playing field, meaning there’s not a government oversight, we welcome competition.

Joseph Moore

Yes. And the microcontroller business, there is a lot of focus on start-up MCU companies in China and spot prices of MCUs in China, which seems like there is no spot market in the shortage end. So it’s kind of an odd concept for me. Can you talk about excuse me – but can you talk to barriers to entry in MCUs, it’s a broad market. You require a broad range of products to be successful?

Jeff Palmer

I think you have to remember on MCUs, very similar to FPGAs. These are programmable devices. When they leave our factory, they are dumb pieces of silicon. You need to provide software enablement tools, for customers to write the code to. You have to provide firmware for them.

And so, there’s a high barrier to entry for providing those tools in that capability. And that’s why, it also does take a longer time, I believe, from design win, to revenue and microcontrollers, because there’s a higher software component.

Joseph Moore

Great. And then just going back to the pricing debate, because it is something that people ask about a lot. We have a couple of minutes to talk about it. You talked about, not seeing any reason for major degradation, for giving that back. Can you talk about why? Because when prices went up, it was because foundry costs were going up. If those costs reverse, do you see that as passing that or…?

Jeff Palmer

Currently today for all of ’24, we don’t see that as the case. I think you do hear of pricing going down in what we would call second and third-tier foundry quotes. But your kind of Tier 1 foundry quotes or TSMCs, your GlobalFoundries, these type of folks, they’re not lowering prices. And so, if our prices aren’t coming down, how are we going to pass on lower cost to our customers, unless you as our owners, are happy with compressed gross margin, which I don’t think you are.

Joseph Moore

Right. And the way you’re talking about in 2025, a return to maybe a modest downward. Is that normal? Is that like back to normal, like down 2% or so?

Jeff Palmer

Well, pre-COVID we were down to about low single digit, 1% to 2% annual cost concessions to customers, and that really represented our operational efficiency, right? You eke out a couple of points every year, you pass on a little bit to your customer.

Joseph Moore

But I mean, to your point, you never really saw the gross margin expansion from raise prices there may be some other sauces?

Jeff Palmer

That’s correct. And I think that’s really what differentiates NXP. How we approach pricing and inflationary costs, as we aggregated together all of our inflationary costs. And we spread those costs across almost all of our end markets, not all, but almost all of our end markets in a very peanut butter fashion, because it just was too difficult for us to go out and say, customer A, buys a product from TSMC customer B, buys a product from GlobalFoundries. So, we just basically aggregated that cost up across the board.

Joseph Moore

Okay. And there’s actually, yes we do have one question from the audience?

Unidentified Analyst

Thanks for being here. I was just wondering what your thoughts on M&A are currently and whether there’s any technological capabilities you’d be looking, to enhance in the future?

Jeff Palmer

Great. So, I guess kind of part of the capital allocation strategy comment. So, we do M&A sub-$100 million type opportunities. These are small opportunities, tuck-ins, design teams, IP, what have you. Large transformative M&A, while interesting, just the environment is not conducive to that. Almost every large deal would have to go through China.

And then they have a lot more, what I think are geopolitical risks, both in U.S. and Europe about any sort of large M&A. But long-term, if you could take the governmental oversight and put it aside for a second, I think our industry does need to continue to consolidate.

Joseph Moore

It’s been a long time now, but how do you guys feel about Freescale at this point? I mean there was some ups and downs around that. But obviously, some of the core capabilities you talked about came from the Freescale side?

Jeff Palmer

In the limit, it was an excellent deal. Was it easy? No. I mean – like all M&A. It looks so pretty and beautiful the day you buy it. And then you get in there, and you realize you have some things that are not exactly what you thought. But in terms of what it provided us and the complementariness, of what our existing kind of pre or legacy NXP portfolio, it was a great deal. Great deal. And we would do it again today, if it was on the table again.

Joseph Moore

Yes, if there was a regulatory environment?

Jeff Palmer

Yes, exactly.

Joseph Moore

Got it. Okay. All right. Any more questions from the audience? If not, we’ll wrap it up. There’s one more.

Unidentified Analyst

Hi Jeff.

Jeff Palmer

Hi.

Unidentified Analyst

You guys have been an excellent gross margin story through time, given that now the cost structure is such that you have 30% fixed, 70% flexible. Is there still a gross margin story from here? Or is it just getting more difficult?

Jeff Palmer

Well, I’m going to quote my CFO and my boss’s statement. 58% is not the destination. And the way to maybe think about this, if I could maybe put some crumbs on the ground for you, if you think about our channel, a little over half of our revenue. The channel is effectively a margin accretive channel for us. As we start to refill that channel back up to the two and a half months, that’s a margin accretive event. At a certain point, by refilling the channel, you’re going to burn off DIO on the balance sheet.

At a certain point, we’re going to have to start wafers again in our internal factories and drive the utilization back up to the mid-80s, again, another margin accretive type of tactical event. So those two things won’t be synchronized, but that’s the way to kind of think of the drivers that could drive gross margin higher over the long-term.

Unidentified Analyst

And can you also comment on operating leverage, right, when that gross margin starts to recover? Or not recover, but goes towards the 58%. How much additional operating leverage can you drive?

Jeff Palmer

So we don’t really provide like a gross margin leverage structure like that. Our model is 55% to 58% gross on OpEx. We run 16% R&D, 6% to 7% SG&A. We have more projects than we have R&D that we’ll allocate to. So, we’re going to continue, to probably run at that 16%, because R&D for us is the lifeblood of the company. So you can kind of do the chainsaw math, as gross margins grow and revenue grows, you will get some leverage on the operating line.

Joseph Moore

Great. Any other questions? Okay. We’ll wrap it up there. Jeff, thank you very much.

Jeff Palmer

Great. Appreciate it.

Joseph Moore

Thank you, everyone.