GLOBALFOUNDRIES Inc. (NASDAQ:GFS) Q3 2023 Earnings Call Transcript

GLOBALFOUNDRIES Inc. (NASDAQ:GFS) Q3 2023 Earnings Call Transcript November 7, 2023

GLOBALFOUNDRIES Inc. beats earnings expectations. Reported EPS is $0.55, expectations were $0.5.

Operator: Good day and thank you for standing by. Welcome to GlobalFoundries Third Quarter of Fiscal Year 2023 Financial Results Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today’s conference is being recorded. I would now like to hand the conference over to, Sam Franklin, Head of Investor Relations. Please go ahead.

Sam Franklin: Thank you, operator. Good morning, everyone, and welcome to GlobalFoundries third quarter 2023 earnings call. On the call with me today are Dr. Thomas Caulfield, CEO; David Reeder, CFO; and Niels Anderskouv, Chief Business Officer. A short while ago, we released GF’s third quarter financial results, which are available on our website at investors.gf.com along with today’s accompanying slide presentation. This call is being recorded, and a replay will be made available on our Investor Relations web page. During this call, we will present both IFRS and adjusted non-IFRS financial measures. The most directly comparable IFRS measures and reconciliations for adjusted non-IFRS measures are available in today’s press release and accompanying slides.

I’d remind you that these financial results are unaudited and subject to change. Certain statements on today’s call may be deemed to be forward-looking statements. Such statements can be identified by terms such as believe, expect, intend, anticipate, and may or by the use of the future tense. You should not place some due reliance on forward-looking statements. Actual results can differ materially from these forward-looking statements, and we do not undertake any obligation to update any forward-looking statements we make today. For more information about factors that may cause actual results to differ materially from forward-looking statements, please refer to the press release we issued today as well as risks and uncertainties described in our SEC filings, including in the sections under the caption Risk Factors in our annual report on Form 20-F filed with the SEC on April 14, 2023.

We’ll begin today’s call with Tom providing a summary update on the current business environment and technologies, following which Dave will provide details on our end markets and third quarter results and also provide fourth quarter 2023 guidance. We will then open the call for questions with Tom, Dave and Neils. We request that you please limit your questions to one with one follow-up. I’ll now turn the call over to Tom for his prepared remarks.

Thomas Caulfield: Thank you, Sam and welcome to everyone joining our third quarter earnings call. Against the backdrop of ongoing global economic and geopolitical uncertainties, our dedicated teams worldwide have achieved third quarter results that are at the upper end of the guidance ranges we outlined in our second quarter update. I’m very proud of their execution and resilience. Let me start by providing a brief update on the current business landscape. Similar to others in the industry, we anticipate that semiconductor inventories will persist at high levels across multiple end markets through the end of 2023 and in many cases into 2024. Specific end markets that we serve, such as smart mobile devices, communications infrastructure, data center and the lower end of the consumer and home electronics segment continue to grapple with increased inventory compounded by decreased year-over-year demand.

To manage elevated inventory some customers have requested shipment adjustments and alterations to their long-term agreements. We are collaborating closely with these customers to support their short-term inventory reductions and avoid prolonging the duration of the inventory correction. In addition to working collaboratively with our customers, our primary objective throughout all of these negotiations is to safeguard the long-term value of these agreements. In some cases these discussions have led to underutilization charges related to these adjustments. Dave will elaborate on this in his remarks, but we expect these productive conversations to continue during the fourth quarter, as we work collaboratively to address ongoing market challenges.

Expanding on our second quarter update, we believe a return to year-over-year growth in 2024 will be contingent upon inventories significantly declining from their current levels and a concurrent marked recovery in global demand, particularly across consumer-centric end markets. Based on discussions with our customers, we believe that the required catalyst for growth will at a minimum remain uncertain at least through the remainder of the year. Now despite these industry headwinds, we’re still witnessing resilient demand in key end markets like Automotive, Industrial IoT and Aerospace and Defense. As semiconductors play an increasingly vital role in these critical sectors, we’ve unveiled exciting partnerships in product developments which I will discuss shortly.

Let me now touch briefly on our third quarter results which Dave will discuss in more detail later in his commentary. Revenue in the quarter increased sequentially to $1.852 billion which was above the midpoint of our guidance range. We reported adjusted gross margin of 29.2% in the quarter, which exceeded our guidance range. This better-than-expected performance was driven by the continued efforts of our teams around the world to optimize our manufacturing spending as well as the successful resolution of adjustments to customers’ near-term volume requirements and the associated underutilization payments which Dave will discuss in his commentary. We delivered a consecutive quarter of positive free cash flow, which continues our disciplined approach to capital management and deployment while preserving our strategic capacity expansion objectives.

I am also pleased to report, that we delivered adjusted earnings per share of $0.55 which exceeded the high-end of our guidance range. Let me now provide you a brief update on some of our recent customer partnership activity. Starting with Automotive, we delivered another quarter of solid revenue growth. Our Auto-Grade Technology Platform, continue to serve crucial applications across vehicle infrastructure smart sensing, auto processing and safety. We remain focused on providing best-in-class solutions to our customers, while supporting the transition of the industry from internal combustion engine models to autonomous connected electrified vehicles. This remains an exciting growth vector for us and one where we continue to grow our customer partnerships with the development of Automotive-grade to semiconductor solutions.

I’m pleased to report that we remain on track to deliver $1 billion of automotive end market revenue, in 2023. In smart mobile devices, we continue to remix our business towards the premium-tier handset market where we have seen greater resilience in demand and opportunities to build upon our feature-rich solutions. At our Annual Technology Summit in August, we launched 9SW RFSOI Technology Platform which is our most advanced RF solution and will offer significant improvements in switching performance, lower power consumption and area advantages in front-end modules for today’s 5G operating frequencies as well as future 5G mobile and wireless communication applications. Meanwhile in IoT, we recently announced advancements to our industry-leading 22FDX platform, introducing a suite of innovative features such as, ultra-low power memory and temperature-resistant capabilities to deliver top-tier performance and intelligent power consumption.

With a rapidly expanding network of globally connected IoT devices, we continue to see opportunities for innovation across our differentiated technologies focused on enhanced power efficiency and embedded memory for secure intelligence solutions at the edge. We are already designed into several products that utilize domain-specific architectures to support various AI at the edge applications, such as our 55 LPx platform supporting Oculi’s embedded intelligence sensors and our 22FDX manufacturing process being designed into Nordic’s latest generation of low-power wireless SoCs with workload optimized processes that support complex machine learning and sensor fusion at the edge. Aerospace and defense is another important growth area within IoT, as the focus on national and international security takes an increasingly prominent role on the global stage.

We are proud to have extended our partnership with the U.S. Department of Defense with the award of a 10-year contract for the supply of secure semiconductors for use across a wide range of critical applications. Finally, communications infrastructure and data center remains a challenged end market within our portfolio. Consistent with previous downturns, we believe that this is due to a combination of elevated inventory levels and the acceleration of node migration from data center and digital-centric customers to single-digit nanometers. As discussed during our second quarter earnings update, we expect that elevated inventories will continue at least until the end of the year due to the prolonged channel digestion of both wireless and wired infrastructure inventory levels across our customers.

As a result, we continue to focus on opportunities to remix some of our excess capacity to service demand in more durable and growing segments such as automotive. Turning briefly to our capacity additions. We continue to develop our global footprint in a measured and capital-efficient manner in geographies that align with our customer supply chain requirements. In September, I was proud to attend the opening ceremony for our $4 billion Fab 7h expansion in Singapore, which will have the capacity to produce approximately 450,000 300-millimeter wafers annually. And I’m pleased to report that the incremental capacity is already helping to meet customer demand. When it comes to considering the timing of incremental capacity additions, we will remain highly disciplined in assessing the broader market conditions and committed customer demand.

To summarize, I’m pleased to report financial performance, which exceeded several of the guidance metrics identified in our second quarter update. Notwithstanding, the deeper and longer-than-expected downturn impacting our industry our dedicated teams around the world continue to execute on the targets that we set out to deliver for our customers and our stakeholders. Although, we remain cautious on the near-term outlook, over the longer-term, we continue to see a secular acceleration of the role of semiconductors in the world, and we are committed to developing deep customer partnerships and investing in innovative feature-rich solutions, so that GF can play an increasingly vital role in the future of our industry. With that over to you, Dave.

David Reeder: Thank you, Tom, and welcome to our third quarter earnings call. For the remainder of the call, including guidance other than revenue, cash flow, CapEx and net interest and other expense, I will reference adjusted metrics, which exclude stock-based compensation and restructuring charges. As Tom noted our third quarter results were at the upper end of the guidance ranges we provided in our last quarterly update. Third quarter revenue grew sequentially to approximately $1.852 billion, a decrease of 11% year-over-year. These results included approximately $23 million of revenue related to customers’ adjustments to their near-term volume requirements. We shipped approximately 575,000 300-millimeter equivalent wafers in the quarter, a 10% decrease from the prior year period.

ASP or average selling price per wafer, declined approximately 2% year-over-year mainly driven by changes in the product mix shift during the quarter. Despite the modest decline in ASPs during the quarter, we expect that the pricing environment will remain stable through the end of 2023 and we believe that ASPs for the full year will be roughly flat to slightly up compared to 2022. Wafer revenue from our end markets accounted for approximately 89% of total revenue. Non-wafer revenue, which excludes revenue from reticles, nonrecurring engineering, expedite fees and other items, accounted for approximately 11% of total revenue for the third quarter. Let me now provide an update on our revenues by end markets. Smart mobile devices, represented approximately 42% of the quarter’s total revenue.

Third quarter revenue decreased approximately 1% sequentially and decreased roughly 18% from the prior year period, principally driven by ongoing weakness in the demand environment and a continuation of the well-publicized inventory correction within the broader smart mobile market. Despite these reduced volumes, ASP and mix improved year-over-year as we continue to remix to the premium end of the smartphone market. We expect the pricing benefits associated with these mix improvements, to be higher for the full year as compared to 2022. During the third quarter, shipment volumes decreased sequentially which was primarily due to the excess channel inventory. However, we continued to see healthy demand during the quarter for our RF transceiver solutions into premium tier handsets.

As Tom noted in his prepared remarks, we believe that inventory levels across smart mobile devices will remain elevated going into the year-end, as the rate and pace of demand growth is slower than previously anticipated. In the third quarter, revenue for the home and industrial IoT markets represented approximately 20% of the quarter’s total revenue. Third quarter revenue increased approximately 4% sequentially and declined 7% from the year prior period. The consumer-centric portion of our IoT end market, primarily contributed to the year-over-year declines as well as modest declines in ASP and mix within the quarter. For the full year, we expect that ASPs within home and industrial IoT will be roughly flat compared to the prior year. We continue to see stable demand within our home and industrial IoT segment, which is helping to offset some of the weakness in the consumer-centric portions of the portfolio.

The demand for our smart card technology grew again in the third quarter as the confluence of speed, convenience and transaction integrity are enabling applications to expand beyond digital payments and into areas such as transportation, government, health, security and access control. As Tom noted in his prepared remarks, aerospace and defense is a segment of growing importance within IoT where we continue to grow design wins and establish new partnerships to deliver best-in-class semiconductor manufacturing security and traceability. As a result, we expect increasing near-term customer demand for our next-generation analog and mixed-signal technologies into these end markets to largely offset the current inventory correction and market softness in the more consumer-centric portions of the IoT market.

Automotive continues to be a stable growth segment for us and represented approximately 17% of the quarter’s total revenue. Third quarter revenue increased approximately 24% sequentially and roughly 219% from the year prior period, driven by healthy growth in volumes, ASP, and mix as we have continued to ramp production across automotive processing, sensing, vehicle infrastructure, and safety applications. The pricing environment within automotive remains highly constructive as the silicon content functionality and applications across ICE and ACE vehicle architecture continue to grow year-over-year. As part of our discussions with customers, supply chain certainty continues to be a key consideration for existing and future designs and GF is uniquely positioned to meet these needs by investing in capacity across our globally diverse manufacturing footprint.

As Tom noted, our automotive business is on track to deliver approximately $1 billion of revenue in 2023, consistent with what we communicated at the start of the year. Next, moving to our communications infrastructure and data center end market, which represented approximately 8% of the quarter’s total revenue. Third quarter revenue declined approximately 26% sequentially and roughly 58% year-over-year as a result of declining volumes and the key drivers outlined by Tom in his prepared remarks. As noted during our second quarter update, we expect to see a decline in revenues for this end market through the end of 2023 and as mentioned by Tom, we will continue to allocate manufacturing capacity into more durable and accretive markets such as automotive and premium smart mobile applications.

Finally, our personal computing end market represented approximately 2% of the quarter’s total revenue. Third quarter revenue declined approximately 29% sequentially and 23% year-over-year, principally driven by declining volume in this segment. Although we anticipate a sequential increase in PC end market revenue in the fourth quarter, we still expect this end market to remain at approximately 3% of total 2023 revenue. Moving next to gross profit. For the third quarter, we delivered gross profit of $541 million, which was at the high end of our guided range and translates into approximately 29.2% gross margin. Gross margin exceeded the guidance range indicated, and as Tom alluded to in his prepared remarks, includes manufacturing cost efficiencies and revenue associated with the successful resolution of customer volume adjustments.

Looking ahead to the fourth quarter, we expect some of these benefits to subside and this has been reflected in our fourth quarter guidance. Operating expenses for the third quarter represented approximately 12% of total revenue. R&D for the quarter was roughly flat at $101 million and SG&A increased sequentially to $118 million. Total operating expenses increased sequentially to $219 million in the quarter. We expect total operating expenses to decline in the fourth quarter and included in our guidance is the expectation that we will receive approximately $30 million of benefit related to the advanced manufacturing and investment tax credit. As we continue to spend on qualifying US expenses and capitalized assets in 2024 and beyond, we expect to continue to receive these benefits through the life of the program.

We delivered operating profit of $322 million for the quarter, which translates into an approximately 17.4% operating margin, which was above the high end of our guided range and 140 bps below the prior year period. Third quarter net interest and other expense was $18 million and we incurred a tax benefit of $4 million in the quarter. Our third quarter net income increased sequentially to approximately $308 million, but represented a decrease of approximately $60 million from the year-ago period. As a result, we reported a sequential increase in diluted earnings of $0.55 per share for the third quarter. Let me now provide some key balance sheet and cash flow metrics. Cash flow from operations for the third quarter was $416 million. CapEx for the quarter was $323 million or roughly 17% of revenue.

Free cash flow for the quarter, which we define as net cash provided by operating activities, less purchases of property plant equipment and intangible assets as set out on the statement of cash flows was $93 million. At the end of the third quarter, our combined total of cash, cash equivalents and marketable securities stood at approximately $3.36 billion. We also have a $1 billion revolving credit facility which remains undrawn. Next, let me provide you with our outlook for the fourth quarter. We expect total GF revenue to be between $1.825 billion and $1.875 billion. Of this, we expect non-wafer revenue to be approximately 11% of total revenue. We expect gross profit to be between $502 million and $544 million. We expect operating profit to be between $327 million and $389 million.

Excluding share-based compensation, but including the benefit related to the advanced manufacturing investment tax credit, for the fourth quarter, we expect total OpEx to be between $155 million and $175 million. At the midpoint of our guidance, we expect share-based compensation to be approximately $45 million of which roughly $14 million is related to cost of goods sold and approximately $31 million is related to OpEx. We expect net interest and other expense for the quarter to be between $7 million and $13 million and tax expense to be between $18 million and $24 million. We expect net income to be between $296 million and $358 million. On a fully diluted share count of approximately 557 million shares, we expect adjusted earnings per share for the fourth quarter to be between $0.53 and $0.64.

Consistent with our commentary in August, our fourth quarter guidance reflects the expectation that utilization will be in the low to mid-80s for the full year of 2023 due to prevailing demand environment and elevated inventory levels that Tom outlined earlier. As we discussed in our second quarter update for the full year of 2023, we now expect CapEx to be approximately $2 billion. As Tom noted in his prepared remarks, we remain on track to meet the capacity footprint aspirations that we set out in our strategic objectives and based upon our CapEx commitments. As part of our fourth quarter results, we will provide more specific guidance on our CapEx targets for 2024. However, we anticipate a material year-over-year reduction in CapEx as we focus on delivering significant year-over-year free cash flow generation.

In summary, consistent operational performance from our dedicated employees across the world and continued efforts to expand our differentiated product offerings in key growth segments enabled us to achieve third quarter results at the high end of the guidance ranges we provided in our second quarter earnings update. We remain acutely focused on the fourth quarter and year-over-year demand outlook heading into 2024, as well as positioning GF for long-term growth opportunities. With that, let’s open the call for Q&A. Operator?

Operator: Thank you. We will now conduct a question-and-answer session. [Operator Instructions] Our first question comes from Mark Lipacis from Jefferies. Please go ahead.

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Q&A Session

Mark Lipacis: Hi. Thanks for taking my question. Tom, you had mentioned when you’re talking about customers asking for relief or working collaboratively with you to try to adjust the LTSA. I’m wondering what are the mechanisms that you are using to safeguard the value of those LTSAs. To what extent — is it that your customers are covering the fixed costs associated with what they originally expected to get versus extending an LTSA for a longer period of time, or getting more strategic sockets or higher volume on the back end? If you could help us understand, how that collaboration manifest I think that would be very helpful. Thank you.

Thomas Caulfield: Thank you, and good morning, Mark. You actually answered the question yourself there. Look we started this year we’ll just take a step back as an industry that we were going to be down in the first half and come roaring back in the second half. So in the first half customers were saying let’s build some of that inventory because we have to get ready for the second half and clearly that didn’t happen. And we’re just starting to see now is exactly what these long-term agreements were meant to was to provide a balanced framework by which we as partners with all our customers go through these cycles together. The contracts are so bespoke that it’s — you can’t take — it’s a one-off, right? They’re all unique. But I would tell you the one thing that is common to all of them and you saw in the last quarter we had an underutilization resolution to $23 million is first and foremost let’s not prolong an over-inventory situation.

Let’s figure out what makes sense to build. And then how do you repurpose that capacity for other corridors that maybe there is better demand? How do we go win new design sockets to extend the long-term agreement? Again this is not about one-sided long-term agreement. They were supposed be balanced and partnership driven. Now the last thing I would tell you about these is they’re calendar-based. And that means a lot of the true-up takes place at the end of the year. So I think you can expect to see more of these types of resolutions and alignment as we get through the rest of this quarter. But you’re right it takes the form of many different elements, new design wins, repurposing capacity, extending the life of these contracts. And in some cases a payment for an underutilization is part of that resolution.

I hope that helps.

David Reeder: Do you have a follow-up Mark?

Mark Lipacis: Yeah, I do. Thank you. And I think when we talk about a lower — I appreciate that you’re not giving the guidance on the CapEx for next year. But it sounds like it’s going to be a reduction in 2024, which should translate to a better free cash flow. Is that lower — is what you’re thinking about for CapEx next year is that lower than what you had originally envisioned over the last couple of years? Is that going to be a lower bogey than what you were thinking? Thank you.

David Reeder: It is Mark. And let me just maybe preface that statement with just, kind of, reiterating what we’re trying to achieve. We’re trying to achieve about three million total wafers of capacity. When you look at the funds that we’ve spent over the last three years, we are essentially at that mark. Some of that capacity still to come online. But we are essentially in line with that target. And so, when you think about CapEx for 2024, while we’re not guiding it right now, we’ll guide that in February with our fourth quarter update as well as our first quarter guidance. We’re thinking about something materially lower. So think in terms of kind of half, if not less than half of what we’re spending in 2023.

Mark Lipacis: Very helpful. Thank you.

Operator: Thank you. One moment for our next question. Our next question comes from Ross Seymore from Deutsche Bank. Please go ahead.

Ross Seymore: Hi, guys. Thanks for let me ask the question. Tom, I want to talk a little bit about the linearity of demand. You’ve talked about the correction taking a little bit longer. I think that’s no surprise to anybody. But you guys are holding in quite well despite that. Just wanted to talk about when do you think some of those corrections will be done? We’ve heard data points of green shoots from some other foundry folks on the smart mobile device side of things? Are you seeing that? And is there kind of a rolling basis as to when you’re going to see that normalization by end market? Any color on that would be helpful.

Thomas Caulfield: Yeah. Let me start and then maybe I’ll pass it to my colleagues. You’re right, you can’t think about semi-demand as a monolithic number. It’s really about end markets. And for me when I take a step back, it’s the end markets that were hit the hardest with the highest inventory are the ones that it’s more obvious to see green shoots because you’re kind of bumping along the bottom, and that includes smart mobile devices and a lot of things that are more consumer centric. And so we do see that there may be opportunities for some of that to start growing. And it’s not about just growing off a low base, as it will be a significant growth or not. It’s nice to see that by and large, inventories have either peaked or came close to peak and in some cases have come down in some of those markets and that’s the beginning of getting a recovery where demand will not be able to drive further growth.

I’d say that automotive while you hear some noise in the industry, it could soften maybe that’s because it’s been such a strong year for automotive. But it remains strong and as we said in our prepared comments that we’re feeling really good about producing $1 billion of revenue this year in automotive market. That’s up from about $375 million last year. So I really think it’s about all of us watching inventory by end market and then how do we go get this consumer-led spending industry supercharged with consumers again. And that will be the — it touches many of the end markets when that takes place. Niels, David anything you’d add to that?

Niels Anderskouv: Maybe I can add a little bit on the momentum we’re seeing on the design win side. So automotive, obviously, very pleased with the results as Tom said. And we talked about in previous calls that a lot of what we are enjoying this year, two to three years ago, we made those design wins. But I’d like to say it also we continue to be very pleased with the design and momentum that we have in that space. And it’s similar comments for IoT. We talked a little bit about SMD in the opening how we are getting more and more focused on the high-end tier phones there. See a little bit of in what you call green, sorry green shoots, especially in the RF area there. And then, of course, A&D we continue to be pleased with the momentum we are building on that front as well.

David Reeder: Did you have a follow-up Ross?

Ross Seymore: Yes. I just wanted to pivot to you David over on the gross margin side of things. You guys have held that in well despite utilization coming down and all the gyrations on the mix side. I’m sure it’s more challenging than we can appreciate. But as we think about the fourth quarter sequentially and then more importantly, the puts and takes for 2024, I appreciate demand is uncertain but you talked about your wafer output, capacity being normalized now to your target rate and some of the CapEx you’re doing, et cetera. What are the puts and takes as we think about gross margin going into 2024?

David Reeder: Thanks, Ross. And let me speak generally first and then maybe I’ll speak specifically, about some of the puts and takes. Look, we’re quite pleased with how we’ve rebaselined our cost structure, such that we can largely absorb headwinds of about six to eight points associated with call it roughly 20 points decrease in demand utilization. And that doesn’t happen by accident. So there’s a lot of great work from roughly 13,000 employees around the world at GF to be able to accomplish that result. And so we’re very pleased with how we’ve rebaselined things from a cost structure perspective on the manufacturing side. Still plenty of work to do but we’ve come a long way. With respect to the third quarter some puts and takes look we received about one point of benefit from the successful resolution of some of those LTA under utilizations that we mentioned in the prepared commentary.