Intel Corporation (INTC) Earnings Call Transcript & Summary

Thank you for standing by, and welcome to the semiconductor co-investment program announcement August 23, 2022. [Operator Instructions] As a reminder, today's program may be recorded. And now I'd like to introduce your host for today's program, Mr. John Pitzer, Head of Investor Relations. Please go ahead, sir.

Yes. Thank you, Jonathan. Good morning, and welcome to our conference call to discuss Intel's announcement with Brookfield Asset Management outlining our semiconductor co-investment program, or SCIP. Joining me this morning is Dave Zinsner, Intel's Chief Financial Officer, who will go through some prepared comments on this first-of-its-kind program for the semiconductor industry, how it underscores our Smart Capital strategy and how it will help accelerate our IDM 2.0. Following his comments, Dave will be joined by Keyvan Esfarjani, Executive Vice President and Chief Global Operations Officer at Intel, in order to answer your questions you have about today's announcement. A replay of today's audiocast will be available later today by visiting Intel's investor website, intc.com. Our discussion today will include forward-looking statements relative to our outlook, expectations and beliefs. These statements are based on the environment as we currently see it and are subject to a number of risks and uncertainties that could cause actual results to differ materially. We will also be providing non-GAAP financial measures during this discussion. Please review our press release announcement regarding the proposed transaction as well as our SEC filings on intel.com, for further details regarding these risks and uncertainties. With that, let me turn things over to Dave.

Thank you, John, and I want to thank everyone for joining us on a relatively short notice this morning to discuss the announcement of our semiconductor co-investment program, an arrangement with Brookfield Asset Management, and what we see as an important pillar to our Smart Capital strategy discussed at our February investor meeting. Capital allocation towards the highest ROI projects is a top priority as we optimize the business. We're in the midst of a transformation to regain manufacturing and product leadership, which we understand involves accelerating investments in both CapEx and OpEx. And we look at our Smart Capital strategy as providing velocity and flexibility as we progress on this journey. As we highlighted at our investor meeting, there are 5 key elements of our Smart Capital strategy: number one, aggressively build out relatively low-cost shelves to give ourselves flexibility to more quickly bring on additional capacity as needed; number two, thoughtfully use third-party foundries to optimize our product road map; number three, take advantage of government incentives to provide a level playing field for building a geographically diverse and more secure manufacturing network; number four, customer participation in our internal capacity build-out as we execute to our foundry strategy; and number five, which relates to today's announcement, leverage agreements with third parties interested in participating in this great industry. In combination, we see our Smart Capital strategy providing both financial guardrails and points of acceleration to return to a leadership position across all our products more quickly. Velocity on executing our strategy is the highest ROI we can provide to our owners. The semiconductor industry is among the most capital-intensive industries in the world, and Intel's bold IDM 2.0 strategy demands a unique and innovative approach to capital management. We are already putting points on the board with our Smart Capital strategy. First, we're making investments in shelf space. In 2021, approximately 35% of our CapEx was spent on infrastructure. We're aggressively investing in shelf space to give ourselves flexibility in how and when we bring additional capacity online based on milestone triggers such as product readiness, market conditions and customer commitments. That spend is the much smaller portion of the cost of a fab, and it's spent over several years. Then we equip that space, which is the vast majority of the cost in a very disciplined way and as needed based on customer demand. The initial infrastructure spend only triggers depreciation when the fab starts up and has longer depreciable lives, which limits the pressure on gross margins. Second, we'll exercise external foundry capacity to increase flexibility, optimize our road map and manage our capacity peaks. As we move to a disaggregated road map, we have even more options as we can make capacity decisions on a tile-by-tile basis based on both the performance requirements and the capital envelope we want to drive. Third, several IFS customers have indicated a willingness to make advanced payments to secure capacity from Intel. We're an attractive option for customers looking for foundry partners with a diverse manufacturing footprint and the opportunity to leverage our huge IPO portfolio. These customers also provide us with the advantage of committed volume, which derisks investments while providing capacity corridors for our foundry customers. Fourth, we continue to look to partner with local and federal governments, and we're thrilled that President Biden recently signed the Chips and Science Act, which provided the funding for the groundbreaking CHIPS Act passed in 2021. We also expect increasing support from state governments across the U.S., and we're pleased with the strong momentum we continue to see in Europe. These government incentives helped level the playing field in the U.S. and Europe as other countries have been incentivizing their nation's manufacturing industries through favorable grants, tax credits and other incentives for years. It's also important to note that in addition to supply assurance for the leading edge, advanced fabs can be a growth engine for the local economies in which they're located. And finally, as part of today's announcement, we've established a semiconductor co-investment program, or SCIP, to optimize our investments in new fab projects. Building off the MOU we announced earlier this year, today, we have signed a definitive agreement with Brookfield, one of the largest global alternative asset managers, through which we will jointly fund Intel's 2 new leading edge manufacturing sites in Arizona. SCIP will increase Intel's capital flexibility and support Intel's manufacturing build-outs. It allows us to fully leverage a premier financial institution to scale our capacity in a capital-efficient manner. Importantly, it also shows how private capital can be a force multiplier to government incentives for semiconductor manufacturing expansion. Government support, customer participation and our semiconductor co-investment program are important offsets to our capital spending. As I shared in February, we have assumed these offsets to be roughly 10% of our 5-year gross capital expenditures but our goal is to achieve 20% to 30%. We believe this is a reasonable goal. In 2022, for example, we expect our offsets to meaningfully eclipse 10% of our gross CapEx. As we examine the various opportunities for offsets, we know we won't get the entire pool of funds, but we're confident we will get our fair share to further invest in and accelerate our transformation strategy. Let me now discuss today's news in more detail. This is a first-of-its-kind manufacturing co-investment program for the semiconductor industry in which Brookfield will be our first partner. Brookfield has helped fund and successfully execute large-scale projects from 5G build-outs globally and fiber-to-the-home in Europe. These types of co-investments have been in place for many years in other capital-intensive industries, and Brookfield's commitment to this partnership is based on their confidence in our manufacturing leadership and foundry strategy. This program opens the door to a new source of capital, which we estimate to be sized at $2 trillion, providing ample capacity for additional programs with multiple partners over time. Extending this model to the capital-intensive semiconductor industry is one of the innovative ways Intel plans to fund its capital commitments and accelerate its IDM 2.0 strategy. We believe partnerships with institutions like Brookfield will provide Intel with a new and expanded pool of capital. Intel and Brookfield will jointly invest up to $30 billion in Intel's manufacturing expansion at its Ocotillo campus in Chandler, Arizona with Intel funding 51% of the total project cost and Brookfield's funding the remaining 49%. Intel will retain a majority ownership and control of the 2 new leading-edge chip factories in Chandler, which will support long-term demand for Intel's products and provide capacity for Intel foundry services customers. There are many anticipated benefits from SCIP. It will protect our strong balance sheet. It allows us to tap into a new pool of capital while protecting our cash and debt capacity for future investments. Adjusted free cash flow will be $15 billion higher, and EPS will be accretive during our investment phase over the next several years. Funding from SCIP is expected to be higher than the cost of debt but lower than the cost of equity. Similar to a customer prepayment, SCIP allows us to better align our cash inflows with our outflows. We expect funding from SCIP will be cumulatively adjusted free cash flow accretive for most of the life of this partnership and allows us to break even on free cash flow earlier. Intel will fully consolidate the new entity's financials and make an adjustment for net income or loss attributable to Brookfield's 49% share of equity. As I shared in February, my goal is to support Intel's growth with an eye on profitability, the balance sheet and a healthy and growing dividend. I committed to managing the business over the long term to a net CapEx intensity of approximately 25% of sales at the steady state, and this continues to hold true. As I also discussed at our investor meeting, over the next few years, we're in an investment phase, which means we will see a short-term rise in our CapEx intensity to catch up on shelf space and accelerate our node transitions. Once we adjust back to a normal node cadence, we intend to adjust our net CapEx intensity back to our longer-term rate of 25%. To hit this goal in a dynamic environment, we must be disciplined with our capital investment and have robust flexible plans that ensure we do not get ahead of ourselves on capacity or spending. This is where our Smart Capital strategy comes into play. SCIP is a subset of our smart capital approach, and Smart Capital is a subset of our capital allocation strategy. Since I joined Intel 7 months ago, I spent every day focused on allocating our owners' capital to maximize long-term value creation. While we've made solid progress, we continue to find opportunities to improve, which will improve Intel's execution to the 5-year business transformation and financial model that Pat and I laid out at investor meetings. As we achieve our ambitions, our employees, our customers, our communities and our owners will all win. I want to close by saying that I'm pleased with the progress we're making on our Smart Capital strategy, including our semiconductor co-investment program and engagement with Brookfield as well as the CHIPS Act. SCIP is a model that we can consider replicating with other partners in other geographies as we accelerate our plans to create a more distributed and resilient supply chain. And in fact, since first addressing equity partnerships as part of our Smart Capital strategy at our investor meeting, we've seen significant enthusiasm about this strategy and expect continued interest for other planned Intel build-outs. Our definitive agreement with Brookfield is expected to close by the end of 2022, subject to customary closing conditions. And now I'd like to invite Keyvan to join me in the Q&A.

Thank you, Dave. I'd like to highlight that the purpose of today's Q&A session is to address the Brookfield announcement and our smart capital strategy. And as such, we would ask that you limit your questions to these topics. [Operator Instructions] Lastly, as Dave mentioned, Keyvan will be joining him for this portion of the call.

[Operator Instructions] And our first question comes from the line of Ross Seymore from Deutsche Bank.

I guess my first one, Dave, you said the cost is somewhere between above debt but below equity. Could you just be a little more precise? What's the cost of the deal over time?

Yes. Thanks, Ross, for the question. So some of the agreement is obviously governed under NDA, so I can't go specifically into the rate. But what I'd tell you is that we just did a debt offering a couple of weeks ago. And that rate, we had about an 18-year maturity on a blended basis, and it was roughly a coupon of 4.4% kind of blended. And so consider debt roughly somewhere in that range. Our cost of equity is somewhere between 8.5%, plus or minus a little bit. So it's somewhere kind of in between that range. I would say another measure would be our weighted average cost of capital, and this -- the rate that we're -- that they're getting is kind of favorable to that rate.

Okay. And I guess for my follow-up, I wanted to just head into the accretion that you mentioned. It seems like it's accretive during the construction and ramp phase, but later on during the production phase. It seems like when you're paying them back. Can you just talk about how that accretion terminology, whether it's EPS or free cash flow accretion transitions over time.

Yes. I would say once the fab ramps to volume, it's relatively consistent through the life. And I would call it kind of nominally dilutive. But it's, as I said, somewhat similar to what you'd see in the debt transaction.

And our next question comes from the line of Vivek Arya from Bank of America.

Dave, since the Analyst Day, the PC volumes are down anywhere between 10% to 20% below the original expectations. I'm curious, let's say if these PC volumes kind of stay at these levels rather than what you thought at Analyst Day, does that change in your mind the funding requirements from CHIPS Act or this SCIP program or your views of cash flow that you thought at Analyst Day?

Yes. So we're still rolling up the CapEx plan for next year. I would say that maybe the best way to describe this is we take somewhat of a longer-term view of CapEx investments. We look at demand over a multiyear period, we have to because the investments we make today in the Arizona facility, for example, won't translate to volume for several years. So our thinking here is that we've got to have a good sense of where we think demand over the longer term is going to be for wafers and invest in our capital accordingly. And based on our outlook in terms of demand for semiconductors, we think that the growth rates look quite attractive. In the near term, obviously, we will fine-tune our capital investments a bit. We also will manage our capacity and our inventory levels to manage through any kind of volatility we see in the near-term demand. I don't know, Keyvan, if you have anything to add to that.

No, no, you hit it right on. The only thing I would say is the core part of our Smart Capital strategy is we are building ahead the shelves, which is a smaller portion of the total investment, and of course, for the larger portion of the investment, which is equipment, those triggers, we will do exactly the kind of assessment you were referencing. It's market, it's the customers, it's the product readiness. All those elements are going to come into play. And for this project, it's still some time until '23 where we have to make those decisions.

And for my follow-up, I'm still trying to assess what is in this program for Brookfield if there are interesting semis, I mean, there are many ways of going and investing in the industry, right, without getting their hands on this particular manufacturing option. So what is the downside protection? So let's say, in the next 3 or 4 years, right, if there are changes in your competitive positioning, right. or if, let's say, the foundry program doesn't become successful, what is the downside protection for an investor like Brookfield in this arrangement?

Yes. I mean here, again, we're not going to go into the particulars of the agreement since we're governed under an NDA. But I'd just say they -- this is a lot like any other transaction that you see Brookfield make in infrastructure like investments. They look at the cash flows of that particular infrastructure investment. They make an assessment of the kind of the risk profile, and they expect a certain level of return as a result of that, and they kind of build that assumption into what their percentage of cash flows are going to look like. And their goal is to get a good return. And so the good thing for us is that the return is, I think, attractive to them but attractive to us in terms of the risk return profile of investing in a fab. The other thing, I think, for them is I think they want to do more of these types of investments across the semiconductor space. This is a first of a kind, but I'm going to guess it's not going to be the last. And so this is a good beachhead for them to have their full foray of investment into semiconductors. And then from there, they'll -- I'm sure they'll look to do other transactions.

And our next question comes from the line of C.J. Muse from Evercore ISI.

I guess, Dave, a few questions here on the structure. You're effectively converting debt into equity. And so what I'm interested in is what do you have to give up to do that. So is there a wafer plus cost kind of an agreement within the structure? Is there a required utilization rate profitability for the structure? Do you have contracted timing of drawdowns from Brookfield? So once you sign the agreement, you're kind of locked in to when you're turning on Arizona. Would love to hear kind of your thoughts around that.

Yes. I mean, clearly, the agreement has elements of all of those, C.J. in there. I think the bigger thing for them is the return. They've got -- they want to achieve a certain level of return. And we kind of conservatively, I would say, estimated what the cash flows had to look like for them to achieve that return and kind of build that in, and it was good for us and good for them. You're right. It's -- there's a certain amount of incremental return that they get above what would be traditional debt to make this make sense for them. And we were comfortable with that level or that rate based on what our expectations would be for the fab. But at the end of the day, we got -- once we build a fab, we got to run it at a fairly high level of volume, no matter what, regardless of whether we are co-investing with a financial partner or we are operating the fab on our own. If the asset sits idle, it's generally not a good return for us. So I think in that regard, it's not too different than where we stand today and the investment we make with the fab.

Okay. I guess as my follow-up, just looking at the last slide on your PowerPoint presentation, where noncontrolling interest is a component of equity as part of SCIP. And I guess within that structure, is it just a guaranteed rate of return or i.e., is it capped? Or depending on the profitability of the fab, they could get paid out even more?

There's a bit of variability. Again, we haven't -- we don't -- we're not going to go into too many of the details. But I think if the fab really exceeds expectations, Intel would get most of that.

Our next question comes from the line of Pierre Ferragu from New Street Research.