GLOBALFOUNDRIES Inc. (GFS) Earnings Call Transcript & Summary

Well, here we go. Well, we'll proceed. Welcome back everyone, toward the end of a long day of a great conference here. So our next speaker is GlobalFoundries. And with us from GlobalFoundries is David Reeder, the CFO. So Dave, welcome, and thanks for coming.

Yes. Thanks for having us. I mean a great -- great conference. Great -- always a great venue here, and it's good to see everybody back after COVID.

It has been. It's been great attendance and a long day. I told Sukhi, I was thinking of just having some bourbon set of water on toward the end of the day.

Especially after that World Cup game. I mean, I heard the cheering and I felt somewhat insecure, because I thought a speaker was really killing it -- and so I was worried about the pressure of coming up here after that presenter. So I was happy to realize it was just the World Cup.

We'll see if you get the same reaction by the end of the presentation, that's what we'll aim for. But so far so good with regard to the GlobalFoundries story. And maybe to start, you could kind of outline where you fit into the ecosystem. And GlobalFoundries has -- the company has been on a journey of its own for the past couple of years that you've kind of changed your focus. And it hits a lot of the sort of messages in the industry now, which is industrial and automotive and some of the growth there, lagging edge versus the leading edge and certainly, some of the geographic diversity that's been important to the industry right now. So maybe that's kind of an opening to give you a minute or 2 to describe where you guys sit.

Sure. And let me -- maybe as a context, I'll talk a little bit about kind of the journey pre-IPO, through IPO and then how we've kind of progressed over the last year in change of being public. And as you may or may not know, I mean, GlobalFoundries has actually been around for 13 years. And I would say the first, call it about the first 8 or 9 years was really kind of putting together the global scale. So there was always this belief that that being geographically diversified and having manufacturing in Singapore and in Dresden in Europe and in the U.S. would be valuable, and it took time to assemble those assets. And then it took time to develop the process technology with the qualified IP cores on that technology. And at the time, the company was pursuing both single-digit nanometer and differentiation on greater than 10-nanometer nodes. And so when the company came to a pivot point in 2018, the company said, progressing down the path of single-digit nanometer probably given the size of GF, didn't make sense. But we have a lot of unique and differentiated technologies that provide real benefit to our customers and in markets where we can help our customers win and in markets, and we can be #1 or #2 in those markets that we then serve. And so you saw the focus in the pivot in 2018. You saw us double down on our investments in differentiated technologies focused around power management, connectivity, RF, high voltage, low power and you saw us make a real focus on being a differentiated semiconductor foundry. And what it enabled us to do was address -- if you think about the TAM of the foundry space, we're able to address a SAM of more than $50 billion, probably round this year and call it closer to [ $60 billion ] actually. And we're solely focused on that portion of the market. We put our best and brightest on that portion of the market. And if you look at some of our competition in that industry, they put their best and brightest, for example, on single-digit nanometer, and so we have this opportunity on more than 50% of the market, more than $50 billion closer to $60 billion to really be focused as an $8 billion company to help our customers win in those markets and have plenty of room to grow over time.

In the meantime, since you made that decision, there's certainly been -- and I'd say good luck and it wasn't all luck, a lot of by design, but we're under some pretty significant capacity constraints now. And maybe that's a place to start in terms of supply-demand balance. Since the IPO, the story for GlobalFoundries really been one of capacity is constrained, your revenue growth is really constrained by your ability to add capacity. And do you think that holds? And I think some of the investor skepticism is a cyclical industry. We've seen some weakness in some places. Does that supply-demand balance hold? And do we get an overcapacity situation at some point in the future like we've seen in the past?

Sure. So luck is when preparation meets opportunity. Right?

It was as a profession way, luck is a residue of hard work...

That's right. That's right. And really, the reason I brought up that pivot in 2018 and our focus on being differentiated is because we pivoted right into some very significant secular trends, right? So everything connected. Everything that's connected now, most of it's untethered. So it's not plugged into the wall, so then you need battery management, right? Then you have the electrification of vehicles, right? So these are all areas of the market that we kind of pivoted straight into. And so -- you fast forward into the late 2020, kind of the early 2021 type time period. And you saw us, we had a lot of design wins from 2019, 2020, early part of 2021, a lot of single source design wins. And so you saw our differentiation start to be recognized by the market where we're helping our customers win in those end markets. And so we laid out a course. I see some investors that were here with us for the pre-IPO roadshow here with us through the IPO for the last 1.5 years or so. And that that plan that we laid out, where we were going to invest for our customers. So when we make capacity investments, we look for 3 things. Do we have a customer that will sign a contract for the output of that capacity increase? Will they participate in the funding? And then will the government also participate in the funding? And if those 3 things check the box and with the right [ ROAC ], then we'll invest. And I think that plan that we outlined at IPO, we've executed on it. We're probably a quarter, maybe 2 quarters ahead. And I think as we look at maybe a more uncertain economic environment in 2023, I think a lot of the questions around the LTA is more than 30 or 38 LTAs now, about $3.8 billion of customer prepayments. There were questions around would those LTAs stand up in an uncertain environment? I think we have at least one proof point that's public. We've had a couple of discussions with other customers and from everything I see, exactly what we expected to happen with those LTAs is happening.

Right. And I think my perception coming out of the IPO, 2 of the areas of pushback was one, as you said, do the LTAs hold up? And thus far, at least a couple of proof points, at least one public as you say, that holds up. And the other is the exposure to wireless, because at this point, 50% of your revenue, give or take...

45% in the third quarter.

45% is wireless exposed. That's one of the areas where we've seen some of the deepest weakness in the space and yet the numbers moved around a bit, but it was, I guess, I consider it a fairly moderate impact.

Sure. And the reason it was a moderate impact when you think about smart mobile wireless decreasing from more than 50% to less than 50% now of our total revenue is not all handsets are the same. And what do I mean by that? So think about like global handset sales, somewhere around 1.2 billion, 1.3 billion global handset sales. I'm not quite sure where we'll finish the year. But when you look within the mix of those handsets, so probably going to be about 650 million handsets this year 5G. Well, GlobalFoundries, one, we have a very big wireless presence, a smart mobile presence. But we're disproportionately attached to 5G. And 5G, I believe, last year was about 450 million handsets, for 5G this year, probably going to be about 650 million handsets. So almost well over 40% growth, right? And if you look at our 5G, that's -- we're experiencing growth in that range, right, like kind of more than 30%. But if you look at 4G where we also have business, that's probably down mid-teens. And so growth in 5G somewhat offset by decline in 4G, but yet smart mobile wireless for us on a year is up kind of low to mid-teens. And so even in a segment that's been challenged, the mix matters and the content, the share of content matters. And so that's an area where we've been able to perform. That stated, look, we think well-known kind of challenges in the PC space. I think we've seen that they were kind of first in. I think you've seen second-hand smart mobile wireless. The second one is in. We expect that to be -- that business or that end market to be a little bit more challenged in 2023, but mix still matters. So as 5G becomes a bigger percentage, it drags our mix along with it.

With the LTAs, you do have a good deal of visibility and you spoke of one that's public, and there's a lot of discussions that you have going on. What's your level of confidence and visibility that the customer's PC handset that have seen declines in their business that they're able to give you that visibility for next year. So you can factor into your expectations for us as well as the expansion plans that you have?

Sure. Yes. When we look at next year, and we said this on our third quarter call, we expect 2023 to still be a modest growth year for us, right? So with all the visibility that we have, our current expectation still holds. We expect 2023 to be a modest growth year. We expect volume to be kind of flattish, maybe slightly down. We expect pricing to be slightly better. And so when you think about that on a year-over-year basis, it translates into modest growth.

And the pricing, as you know, around the IPO was another area of investor concern, right, that it's somewhat unprecedented in semiconductors in the past anyway, they have seen pricing going up, and it certainly has. We've seen -- and some of your customers were on stage earlier today, still expressing a view that structurally in non-leading-edge manufacturing that just cost is structurally going up. So therefore, it's a requirement for the pricing to go up. And I guess with the slowdown we've seen in certain markets, what's your customers' reaction been? Why have your customers been so amenable to continuing to see those price increases?

Sure. So a couple of comments on pricing. And maybe I'll answer this question with a couple of different data points because it's always good to triangulate, right? One, I think everyone recognizes we're in an inflationary environment. I think our customers recognize, I think the end customer recognizes it and I think we as well as our suppliers recognize it, right? So I think from an inflation perspective, there's an expectation that CPI and pricing is something that every industry has to deal with. So I would start with that context. The second thing that I would say is that there's been a greater appreciation for delivery of value out of the business. And so when you can't get a product for a period of time, you realize how valuable it is. And so your ability to capture that value, that discussion becomes easier. So scarcity and when it scarce makes you realize how important it is and so you do get into a bit of mindset around a couple of points extra on ASP is less important to me than do I have security of supply. And so you have the opportunity to have a better value capture discussion. So I would take that point. Some market data context, the market leader in the space, broadly been communicated that the expectation for 2023, that pricing for greater than 10-nanometer nodes will be up mid-single digits. I think that's publicly known from the market leader. And so I think there's kind of an industry expectation when that's the backdrop with a limited number of rational players. Inflation, I think value capture and then you add to that an expectation of the market to have some increases year-over-year, I think that creates a very constructive pricing environment.

All right. What about with regard to the expansion -- capital expansion plans you have over the next year with some of the changes that have happened in the market, how has that altered the CapEx plans for '23 and who knows in '24?

Yes. Let's talk briefly about '22, and then I'll talk about a little bit about '23, at least a framework to think about 2023. We don't actually guide for 2023. We'll do that after we finish up '22. But certainly, we can talk about a framework to think about CapEx for '23. So for 2022, we were originally estimating to spend north of $4 billion in CapEx. And then due to some of the well-known delays in shipment from the WFE providers, we started taking down that CapEx expectation. So it went from $4 billion to kind of $3.5 billion. And if you look at our more recent guidance, closer to $3 billion than $3.5 billion even. And so what we were forced to do as a company was we were forced to become more productive and -- because we still had to deliver to our customer demands. And so we were forced to become more productive. And the good news is that productivity will live with us into the future. So some of that CapEx, that $1 billion of CapEx we were expecting to invest this year, incremental. Some of that will go away for good. Some of it will be pushed out into time. And so then when you look forward to 2023, our cash flow from operations this year is going to be in the range of kind of $2.7 billion. And when you start thinking about an uncertain economic environment, what you want to do is you want to think about being kind of free cash flow neutral, right, or at least free cash flow balanced. And so if next year is slight to modest growth, you could probably think about something of -- you have a CapEx envelope if you want to be free cash flow neutral, somewhere around $2.5 billion to $3 billion. So we kind of think about it in that context. That's not the official guidance for 2023. We'll certainly talk about that CapEx guidance on our fourth quarter call, but it's probably in that type of range. Think about being kind of free cash flow neutral.

Right. And I'd imagine as conditions change, if and when conditions change, you have some flexibility in that. And it sounds like stated the intention is, let's not burn through cash.

That's exactly right. I mean we're very strong from a balance sheet perspective, right? And I'm going to round some numbers here, more than $3.2 billion of cash, roughly $2 billion of debt. So in a very good, very strong balance sheet position. And when you think about the capacity profile that we originally outlined, when we were going through our IPO road show, we were talking about 2.4 million wafers of capacity in '21. We were talking about 2.6 million wafers of capacity this year on track. We were talking about 2.8 million wafers of capacity in '23 and roughly 3.1 million to [ 3.2-ish million ] of capacity in '24, all still holds true. So we're still tracking to all those numbers, plus or minus a little bit. And so what you're seeing us do with our CapEx, the LTAs are still in place. Our customers are still saying long-term, we still want that demand. And so now we're just kind of modulating timing a little bit on most of that CapEx. And to the extent that we become more efficient over time, then we have some CapEx elimination as well. And those are gross CapEx numbers not net of any government sponsorship or something.

Right. And you've hit on kind of 2 follow-on questions. And maybe I'll hit the government participation next. But for right now, and I think it was important out of the IPO also is that we talk about sort of cash flow neutral-ish now. Where in our model, the cash flow sort of inflects is more of the 2024 time frame and the margins as well. So maybe you could speak about that as one is, what's the tailwind for margins in '24? And then what -- do you agree with that sort of inflection in cash flow as you go into 2024?

Right. So when we were going through the IPO roadshow and then the subsequent quarters of being public now, we really outlined, I would say, pretty specifically both before the IPO as well as more recently during Capital Markets Day, we presented a bridge. Here's the bridge on how we get to our long-term financial model, right? It's 8% to 10% revenue growth over time. It's 40% gross margins. It's roughly 25% operating income margin and about 20% capital intensity. And so we outlined that bridge on how we go from where we are today in gross margins to our 40% target. And I would say all of those drivers of gross margin continue to be in play. We've executed on them pretty well. In fact, as I mentioned, we're probably a quarter, maybe 2 quarters ahead with respect to gross margin and overall profitability. So we continue to execute. I think next year, we'll see when we look at the macroeconomic demand next year, what it looks like we see is an inventory correction in semi in the first half with a more normalized environment in the second half. That's our currently kind of our best view. I think that's most of the semiconductor companies that are here. I think that's most of their views. We think first quarter is probably the trough, but we'll work through next year. We think gross margin still largely being on track. We think about 2024 moderation of CapEx still being in play, again, pending additional customer LTAs and it gets additional government support to go with those LTAs. But based on what we see right now, we see all those things we communicated previously still being on track.

But that moderation of CapEx in '24, coupled with just being able to monetize what your spending now is really what drives that cash.

Yes. I don't think that anyone had in their model that we would be close to cash flow neutral this year. Most of the models, if you go back and look, had cash flow of being kind of investing $1 billion more than cash from ops, right, maybe even slightly more than that, and between the operational performance, the customer support, some of the government support, we're actually looking at a year in which we're not going to be exactly free cash flow neutral, but we're going to be much, much closer than originally expected. And then when you think about next year in the framework that I just discussed and obviously ahead of schedule there as well.

Yes. The other part you mentioned is some of the government support, and it's not in your CapEx numbers right now. So what's the status of that? Because understanding is the Act is passed and now it's the implementation that's being decided now. We had some conversation at some of the previous discussions this morning. Maybe you can give an update on that from your perspective.

Sure. And let me start with the context of what should you expect? What should investors expect from GlobalFoundries? I think you'll find that just one of our core tenets is we're going to be very transparent. We're going to tell you what we're going to do, even tell you perhaps how we're going to do it and then tell you how we did, right? And so when you think about the opportunity for some government partnership next year, what you're going to hear from us for guidance is going to be gross. And then to the extent that we [indiscernible] or sign agreements for support, then you're going to get a little paper like -- just like what you got in France. So when we made our announcement, joint partnership with the European Union, France and ST, we released about a 4-page supplementary document that said here's how the economics work, right? And if you go and you look at that document, it's online, it's available to release that to the investment community and all of our constituents. It lays out pretty clearly. Here's what gross is, here's what Singapore look like. Here's what the France partnership looks like. And we'll do the same thing with the U.S. government. So it looks like today, as you know, there's an investment tax credit in ITC. So that means that when you purchase tooling and you install it here in the United States, you get about a 25% tax credit that will come back to you. That will be netted ultimately against the CapEx bill and then would flow through [ DNA ]. That's how that would work geographically on the P&L.

So reduce the depreciation...

Exactly. That's exactly right. So you'd have an asset -- you buy a tool for $10 million, you get 25% credit. It sits on the books at net 7.5% and then that flows through your [ DNA ]. And then, of course, there's the CHIPS Act itself. And the CHIPS Act, you have to kind of preload those projects, so we've got a couple of preloaded projects. They would then go to review with Secretary Raimondo, probably late January, early February, and then there would be some decisions made at which point in time when those decisions are made, if there's news to share, we will share it.

Got it. With a few minutes left, I just want to see if there's any questions from the audience there. I figured you would have a question, Randy.

Actually, I just wanted to ask, I think in the last call, you had the 8-inch was correcting. Could you talk about the sustainability of 12-inch as you look to next year, just the drivers to keep it sustainable? And then the other part, when we look at fabless inventory, it's quite high now. How are the customer conversations? Do they feel comfortable with this new norm? Or are you seeing more across-the-board efforts by customers to drop back down to the old level?

Sure. So 300-millimeter, we're expecting to be fully loaded in 2023. It's essentially fully loaded today. We expect it to be pretty similar in 2023. So we're expecting 300-millimeter utilization to remain quite high. And we think where there's going to be pressure is more on some of the 200-millimeter side. With respect to inventories, we've seen customers be very rational. I would say the customers that we talk to quite frequently. Again, we have 38 LTAs, and we're engaged with customers each and every day. I would say most of those customers have moved very aggressively to start reducing inventory. I think that's quite optimistic for the industry. I think that's why you see this most people modeling in a first half inventory correction and even more weighted to the first quarter is because you've seen those customers to make those moves.

All right. And it's interesting to mention that too because -- and it sounds like the perception is sort of first half inventory correction. Stabilization and improvement in '23 and then perhaps some optimism for 2024. And it's interesting. One of the things I thought was one of the more interesting comments over the last several weeks was ASML in their Analyst Day, and I was asked the question about why they weren't seeing changes and was the answer was, well, the perception is the customers feel that the duration of this downturn is going to be shorter than our equipment lead times, meaning that we're still going to need that equipment in 2024. And it sounds like that you're on board with that and maybe getting that feedback from your customers as well.

Yes. So maybe the right way to answer that question is kind of in the context of our LTAs, right? So we have 38 long-term agreements with customers. They've contributed more than $3.8 billion of prepayments to GlobalFoundries to add capacity for them over a duration of contract that's slightly more than 4 years at this point, right? And so we've had a handful, and I would say, a small handful of customers that have talked to us about adjusting their 2023 demand. They're not talking about, let's talk about '24, let's adjust '25, the conversations have been about adjusting near-term 2023 type demand. And when you put it in the context of agreements that have been amended and signed for the adjustment of that demand, you're talking about adjustments that are less than 5% of the total contract value over that period of time. And so we believe the long-term growth trends are still in place, right? The electrification of vehicles, we think that's going to happen. More devices connected. We think that's going to happen. If more devices are connected, they need power management because they're untethered. We think that is going to happen. And so when you look at the long-term trajectory of some of these macro trends, we believe they're all still true. We believe all the plans that we've communicated and outlined all still true. We believe we've got some inventory to correct. We believe we have a little bit of macroeconomic uncertainty, not for GlobalFoundries before the global economy that we've got to work through a little bit. But we believe that all those long-term trends are -- still hold true.

Do you think that your geographic advantage is also coming into play in terms of, certainly, there's a story for the longer term. The world needs semiconductor capacity outside of Asia, outside of Taiwan, and you could do that. But do you think there's also some at play even for the shorter term in terms of how they may be adjusting the order volumes such that you may be seeing it less than some others because you're just a little bit more insulated to that?

Yes. So a little context. The majority of our business, so 2/3 of our business is single source, 90% of our design wins are single sourced. All of our revenue today -- and in fact, I'd be so bold is to say all of our revenue today, when we originally won that design, we didn't win that design because we are geographically diverse. We won that design because we had the right technology for that customer in that end market. And when we -- when I think about the conversations we're having today, we're having conversations with customers today that one of the most important features is that we're geographically diverse. And that conversation didn't happen a year ago, it didn't happen 2 years ago. It certainly didn't happen 3 or 4 years ago when we won some of these designs. So we believe that's a tailwind. We believe that there is broad recognition amongst our customers, amongst governments, amongst the board rooms that you need to be more geographically and geopolitically diverse to secure your supply chain. And we really like the way we're positioned.

Right. So in the near term, given their sole-source designs, that is not going to have an effect because that's that one particular part -- but over the longer term. And I guess with the conversations over the longer term, is it your view that you just continue to take a larger portion of the foundry business in the markets you participate because...

We believe that the SAM that we serve, we believe that's going to double between now and 2030. And we believe that we have the opportunity, given the position that we're in, both geographically as well as from a technology perspective. We believe that we have a lot of room to grow within that SAM.

That's great. Looks like we're just about out of time. If you have any closing comments.

Yes. I think what I would really like to leave the investor audience with is, hopefully, what you've seen from GlobalFoundries over our short 4 quarters of being public is that we've outlined a very transparent plan. We've communicated that we believe these are the milestones and the metrics that we should be measured by. I would say that, by and large, touchwood, we've executed to that plan, and that's our intention going forward. We have a large SAM that's growing that we believe that we can capture over time. And I think from a geographical diversity, geopolitical diversity, secure supply chain perspective and the technologies and the macro trends that we serve, we believe that all of those elements create a good opportunity for GlobalFoundries long-term. Thank you Chris.

Thanks for coming.

Cheers.

Thanks, everyone.