GlobalFoundries Inc.

Good day, and thank you for standing by. Welcome to Global Foundry's second quarter 2023 earnings conference call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there'll be a question and answer session. To ask a question during the session, you'll need to press star 1-1 on your telephone, and you'll then hear an automated message advising your hand is raised. To withdraw your question, please press star 11 again. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Sam Franklin, VP of Investor Relations. Please go ahead.

Thank you, Operator. Good morning, everyone, and welcome to Global Foundry's second quarter 2023 earnings call. On the call with me today are Dr. Thomas Caulfield, CEO, David Reeder, CFO, and Neil Zanderskoff, Chief Business Officer. A short while ago, we released GF's second 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 webpage. 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 may 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 20F 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 second quarter results and also provide third quarter 2023 guidance. We will then open the call for questions with Tom, Dave, and Niels. 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.

Thank you, Sam, and welcome, everyone, to our second quarter earnings call. I'm pleased to report second quarter results that are at the high end of the guidance we provided in our first quarter update as we continue to deliver consistent financial performance against the backdrop of prolonged macroeconomic and cyclical uncertainty facing our industry. Let me start by providing a brief update on the current business environment. Similar to others in the industry, we believe that semiconductor inventory levels across several end markets are coming down more slowly than previously expected. Certain end markets that we service, such as smart mobile devices, communications infrastructure and data center, as well as the lower end of the consumer and home electronics markets, are being impacted by a combination of increased inventory levels and lower year-over-year demand. Consistent with the discussion in our first quarter update, we continue to believe that the return to more normalized inventory levels in the consumer-centric end markets is forecast to happen more slowly than previously anticipated, and based on our discussions with our customers, will at best occur towards the end of 2023. Though we still expect sequential quarter-on-quarter revenue growth throughout 2023, we believe that the rebalancing of demand for these markets will also extend later into the year and will continue to be impacted while the global macroeconomic and consumer demand outlook remain challenged. Now, despite these headwinds, we continue to see healthy demand in faster-growing end markets, such as automotive, industrial IoT, and aerospace and defense. We have announced some exciting partnerships, which I will comment on shortly, and we are working closely with our customers to support these critical, important markets. Let me now touch briefly on our results, which Dave will discuss in more detail later in his commentary. Revenue in the second quarter increased sequentially to $1.845 billion, which was at the high end of our guidance range. We reported adjusted gross margin of 29.6% in the quarter, which exceeded our guidance range. This better-than-expected performance was primarily driven by the favorable timing of positive manufacturing variance, which is expected to moderate in the second half of 2023. I'm also pleased to report that we delivered adjusted earnings per share of 53 cents, which as well was at the high end of our guidance range. Let me now provide you with a brief update on some of our recent customer and partnership activity. Starting with automotive, we remain highly committed to supporting the transition of the industry from internal combustion engine models to ACE, autonomous connected electrified vehicles. In addition, Our product portfolio is well-placed to support the faster pace of uptake from automotive manufacturers, seeking to compete on differentiated driver experiences and features, as well as on the electronics architecture to comply with evolving safety and security standards. In smart mobile devices, we continue to drive leadership products to remix our business towards the premium tier handset market, where we've seen greater resilience in demand. We also delivered a comprehensive set of features on our 8SW platform, our leading RF silicon on insulator-based product line for front-end module components. Finally, we delivered enhancements to our 28-nanometer High-K metal gate platform, which is purpose-built for the image sensing and processing segment, where we continue to see content growth associated with a trend towards more cameras and pixel processing in mobile devices. Meanwhile, in IoT, We continue to innovate our differentiated technologies focused on enhanced power efficiency and embedded memory for secure intelligent solutions at the edge. We are also proud to have collaborated with Cadence Design Systems to support the development of the industry's first binaural hearing aid systems on chip prototype to create the smart hearing aid processor which will utilize GF's 22FDX platform. In Communications Infrastructure and Data Center, our customers have indicated they are working through inventory levels more slowly than anticipated, which we expect will continue well into the second half of the year. As a result, we've been able to remix some of our capacity service demand in more durable and growing segments, such as automotive. In June, we also announced a strategic collaboration with Lockheed Martin to advance U.S. semiconductor manufacturing and innovation and to increase the security, reliability, and resiliency of domestic supply chains for national security systems. Collaborating with GF will enable Lockheed Martin to more quickly and affordably produce secure solutions that increase the capability and national security of the United States. We are proud to collaborate with Lockheed Martin to address the growing need for a reliable supply of trusted, feature-rich semiconductors for mission-critical security systems. Additionally, Our 300-millimeter FAB in Malta, New York, was recently accredited as a Category 1A trusted supplier by the U.S. government with the ability to manufacture secure semiconductors for a range of critical aerospace and defense applications. This week also marks the one-year anniversary of the signing of the CHIPS Act, and our collaboration with Lockheed Martin directly supports the Act's objectives of increasing traceability, provenance, and onshore production of critical semiconductor technologies to strengthen national and economic security and domestic supply chains. To summarize, I am pleased to report financial performance at the upper end of our guidance range as our dedicated teams around the world continue to execute on the targets that we set out to deliver for our customers and all our stakeholders. With that, over to you, Dave.

Thank you, Tom, and welcome to our second quarter earnings call. For the remainder of the call, including guidance, I will reference adjusted metrics, which exclude stock-based compensation and restructuring charges. As Tom noted, our second quarter results were at the upper end of the guidance range we provided in our last quarterly update. Second quarter revenue grew sequentially to approximately $1.845 billion, a decrease of 7% year-over-year. We shipped approximately 573,000 300 millimeter equivalent wafers in the quarter, a 9% decrease from the prior year period. ASP, or average selling price per wafer, declined approximately 1% year over year, mainly driven by the changes in the product mix shipped during the quarter. Our LTAs, or long-term customer agreements, are helping to provide us with greater visibility on pricing dynamics, and we believe that ASPs for the full year will be flat to slightly up compared to 2022. Wafer revenue from our end markets accounted for approximately 89% of total revenue. Non-wafer revenue, which includes revenue from radicals, non-recurring engineering, expedite fees, and other items, accounted for approximately 11% of total revenue for the second 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. Second quarter revenue increased approximately 13% sequentially, but declined roughly 19% from the prior year period, principally driven by reduced volumes in the low to mid-tier smartphone segments, and a continuation of the well-publicized inventory correction within the broader smart mobile market. Despite these reduced volumes, ASP and MIX was flat year over year, which can be partially attributed to the framework and pricing certainty provided under our LTAs. During the second quarter, shipment volumes increased sequentially, which was primarily due to increased demand for our RF transceiver standalone and SOC solutions into premium tier handsets. Based on the conversations with our customers, we believe that inventory levels across smart mobile devices will remain elevated going into the third quarter as the rate and pace of demand growth is slower than previously anticipated. In the second quarter, revenue for the home and industrial IOT markets represented approximately 19% of the quarter's total revenue. Second quarter revenue increased approximately 4% sequentially and 3% from the year prior period. Year-over-year growth in this end market was primarily driven by improvements in ASP and MIX, which helped to offset a modest decline in volumes stemming from the consumer-centric portion of home IoT. The demand for our smart card technology has continued to grow as applications 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 customer demand for our next-generation analog and mixed signal technologies into these end markets to largely offset the midterm inventory correction and market softness and the more consumer-centric portions of the IoT market. Automotive continues to be a strong growth segment for us and represented approximately 13% of the quarter's total revenue. Second quarter revenue increased approximately 36% sequentially and roughly 199% 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 designs we won several years ago are now ramping into production, and the success of these products across automotive applications, along with our customers' focus on supply chain assurance, has allowed us to invest in significant capacity. As we continue to allocate more capacity to support the continued growth of silicon content across the vehicle architecture, our automotive business is on track to deliver approximately $1 billion of revenue in 2023 consistent with what we communicated at the start of this year. Next, moving on to our communications infrastructure and data center end market, which represented approximately 12% of the quarter's total revenue. Second quarter revenue declined approximately 40% sequentially and roughly 38% year over year as a result of declining volumes, principally driven by the prolonged levels of data center inventory and demand softening for enterprise wired infrastructure. We expect to see a decline in revenues for this end market through the second half of 2023. And as mentioned by Tom, we will continue to allocate manufacturing capacity into more durable and accretive markets such as automotive. Finally, our personal computing end market represented approximately 3% of the quarter's total revenue. Second quarter revenue increased approximately 44% sequentially but declined roughly 45 percent year-over-year, principally driven by declining volume in this segment. We expect this end market to remain at approximately 3 percent of total 2023 revenue. Moving next to gross profit. For the second quarter, we delivered adjusted gross profit of $546 million, which was at the high end of our guided range and translates into approximately 29.6 percent adjusted gross margin. As Tom alluded to, the 160 basis points year-over-year improvement was slightly above the guidance range indicated, which can primarily be attributed to better than forecast manufacturing cost and utilization benefits within the second quarter. We expect the benefit of these items to moderate in the second half of 2023 and have guided our third quarter accordingly. Operating expenses for the second quarter represented approximately 11% of total revenue. R&D for the quarter declined sequentially to $100 million, and SG&A increased sequentially to $108 million. Total operating expenses were $208 million, and we continued to prudently manage our costs. We delivered operating profit of $338 million for the quarter, which translates into an approximately 18% adjusted operating margin, roughly 70 bps better than the year-ago period and above the high end of our guided range. Second quarter net interest and other expense was $10 million, and we incurred a tax expense of $31 million in the quarter. We delivered second quarter adjusted net income of approximately $297 million, a decrease of approximately $20 million from the year-ago period. As a result, we reported adjusted diluted earnings of 53 cents per share for the second quarter. Let me now provide some key balance sheet and cash flow metrics. Cash flow from operations for the second quarter was $546 million. CapEx for the quarter was $400 million, or roughly 22% 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 $146 million. At the end of the second quarter, our combined total of cash, cash equivalents, and marketable securities stood at approximately 3.303 billion. We also have a 1 billion revolving credit facility, which remains undrawn. Next, let me provide you with our outlook for the third quarter. We expect total GF revenue to be between 1.825 and 1.87 billion. Of this, we expect non-WAFER revenue to be approximately 11% of total revenue. We expect adjusted gross profit to be between $502 million and $542 million. We expect adjusted operating profit to be between $277 million and $327 million. Excluding share-based compensation for the third quarter, we expect total OPEX to be between $215 million and $225 million. At the midpoint of our guidance, we expect share-based compensation to be approximately $45 million, of which roughly $16 million is related to cost of goods sold and approximately $29 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 $10 million and $18 million. We expect adjusted net income to be between 254 million and 302 million. On a fully diluted share count of approximately 556 million shares, we expect adjusted earnings per share for the third quarter to be between 46 and 54 cents. As previously communicated during our May earnings call, we anticipated that utilization would run in the mid-80s for 2023. Included in our third quarter guidance is the expectation that utilization will be in the low to mid-80s for the full year 2023 as the well-publicized inventory correction flows through the supply chain. For the full year 2023, we now expect CapEx to be approximately $2 billion, which is a reduction from the guidance of $2.25 billion provided in our first quarter update. We anticipate that this CapEx profile will step down sequentially through the second half of the year. In summary, consistent operational performance from our 13,000 employees and continued efforts to expand our differentiated product offerings in key growth segments enabled us to achieve second quarter results at the high end of the guidance ranges we provided in our first quarter earnings updates. Although we are not immune to the cyclical headwinds currently impacting the broader semiconductor industry, we are implementing initiatives to mitigate the impacts on our business, and we remain deeply focused on positioning GF for future growth opportunities. With that, let's open the call for Q&A. Operator?

Thank you. We'll now conduct the question and answer session. As a reminder, to ask a question, please press star 1 1 on your telephone and wait for your name to be announced. To withdraw your question, please press star 1 1 again. Please stand by while we compile our Q&A roster. One moment. Our first question comes from Ross Seymour of Deutsche Bank. Please proceed.

Hi, guys. Thanks for letting me ask a question. One near-term question and one longer-term question for my follow-up. On the near-term side of things, Tom and David, you talked about in the last quarter about the total year revenues being down mid to high single digits. So I wondered if there's any update on that. And perhaps more importantly, how are the LTSAs holding in? And if the inventory has to be burnt, what are you guys getting in return for lowering the unit side of the equation per the LTSA agreements?

Morning, Ross. I think I'll start with that question, and then maybe Tom will pass it over to you to build on it with respect to the LTAs. You know, Ross, in our prior earnings calls, you know, we forecast that first quarter revenue in 2023 we believed would be our trough, and then that quarter to quarter to quarter that we expected to grow from there sequentially. So we still expect that sequential profile. And as you mentioned, for the full year, we forecast that we expected revenue to decline in the mid to high single digits. We still expect to be in that range. And with our first half results, you know, really now in the books and with our third quarter guidance, you know, you can probably infer from that third quarter with the first half that we are expecting to be towards the high end of that year-over-year range. Tom, do you want to take the LTA question? Yeah, very good.

Look, the premise of the LTAs was to create better balance through a down cycle. It wasn't just to have one side wins and the other side loses. It was to create balance and work through this drop. And I think you see it in our performance quarter on quarter, both in revenue and profitability, that we've been able to manage inventory and manage underutilization fees in a very pragmatic way with our customers to get through this in partnership and I dare to imagine what our world would look like if we didn't have those partnership agreements in place in a downturn like this. Ross, did you have a follow-up?

Yeah, I did. This morning we also had an announcement on the competitive front, TSMC doing a JV with a handful of European either actual or potential customers for GF. Just wondered what your view on that. I can see the positive side is endorsed geographic diversification of manufacturing and the strength of the end markets, et cetera. On the negative side, obviously, those are customers you guys would want, and so more competition in those regions I could see lending some pressure to you guys. So how do you view that announcement from a competing foundry?

Well, we didn't wake up this morning and just see that happening. This has been in the press and the news for a long time. I think you hit on one of the points, but let me comment on three elements of this. Building this capacity is consistent with the supply the world will need in the next decade. This is an industry that's going to double. In fact, German automotive associations have talked about the need for 27 FAFSA loan in Europe to build capacity. GF is not going to go create this capacity on its own. TSMC needs to participate in a meaningful way as well. Yes, those are our customers, but they're also TSMC's customers. No one has a monopoly on any given customer, right? These customers source from many of us on different platforms for different needs. I'd also add to that that, to your point, is in the past, this industry is built on driving huge economies of scale by concentrating supply in one region, and it drove the ultimate in. in cost capability because it had economies of scale. But it created the unintended consequence of huge issues with supply chain resiliency. And so GF in 2009, when we were launched, we were there to create, to begin that thesis that the world needed a more diverse geographic manufacturing capacity for semiconductors. We could all argue maybe that was a little bit ahead of its time, but today it looks like it was a pretty good thought back then. And so what you're seeing is not only you know, our competitors adding capacity that the world needs over the next decade, but they're putting it in a broader footprint to respond to the fact that we need resiliency and supply chain, to your point. But the third thing is greenfield and being able to build in high degree of concentration in one region and now taking that show on the road, as it were, to build in other locations doesn't come very easy. It's very difficult to get the economies of scale, to get the cost, and we see this is putting pressure on cost structures for others that are trying to build a geographically diverse footprint. And that just creates for GF a better pricing environment going forward. So that's how we feel about it. This is not something that – this is the first and last of something like this. The world, if we really believe, needs that kind of capacity. TSMC will need to do their part, not just GF doing our part. I hope that helps, Ross.

Thank you.

Thank you. One moment, please, for our next question. This question is from Mark Lopesas with Jefferies. Please proceed.

Hi. Thanks for taking my question. Coming back to the LTAs, I believe last quarter you noted that you had five new LTAs and some of your customers actually asking for increase in scope. And so I guess I'm wondering, are we, can you give us an update on that pace? Are we kind of at the point where your customers are kind of putting a pause on signing up for new LTAs? Or are you still seeing that kind of extension of, you know, longer term agreements from your customers?

No, great question. There's no pause going on. We are in active discussions with a number of customers. Timing is everything. And sometimes for more substantial ones, it takes a little bit more time for these things to come in place. Again, this comes back to my earlier commentary. It depends what you believe. If you think the industry is done and you have all the capacity you want, then you're not going to look forward and you stay pat. There are plenty of our customers that see their growth opportunity in automotive, IoT, and things of that nature, where they want to make sure they're booking today that certainty of supply for when this industry begins to grow again. And we're working with them in very serious discussions that will eventually come to a close. So LTAs are in our past, and they are certainly in our future, and I think this is the new norm for our industry. David, anything you'd add to that?

Yeah, if I could just build on that briefly. You're right, Mark. We didn't announce that we had signed any new material LTAs this quarter, but we are quite pleased with some of the partnerships that we've announced and that we've developed, you know, Lockheed Martin being one of those, Aerospace and Defense being a key market, in-market for us on a go-forward basis and being a market along with industrial and home and industrial IoT that's performing quite well. We're also very pleased with the progression of our LTA funnel where we have ample opportunities, some of which are quite mature. So, stay tuned for more LTAs in the future. Great.

Did you have a follow-up? Yes, please. On the gross margin side, I don't think I fully understood the timing of the variances and how they We'll moderate going forward. I guess I assume that if you get some progress on your gross margins, you kind of get to keep them. So if you could just provide a little bit more color there, what kind of variances are we talking about? And from the standpoint of timing, were these variances you were expecting to hit in the next quarter? If you just give a little more color, that would be helpful. Thanks. Thanks.

Can do, Mark. Let me give you some kind of specific second quarter commentary and then maybe I'll broaden it out a bit as well. As we mentioned in our prepared commentary, we did benefit a little in the second quarter from some better than expected, quite frankly, unforecasted manufacturing variants. So what is manufacturing variants? It could be anything from reduced input cost. It could be higher utilization. It could be better cost absorption. It could be better pricing that you receive from suppliers. Those would all kind of broadly fall under the category of manufacturing variance. And we received some better than expected manufacturing variance in the second quarter. So in the absence of that benefit, we would have been at the high end of our second quarter guidance range. So we don't really expect that manufacturing variance to kind of continue throughout the second half of this year. And so we reflected that in our guidance accordingly. But purely from a guidance perspective, when we think about third quarter gross margin, to give you some context, our midpoint guidance for third quarter and our upper range for the third quarter is actually higher than what we guided in second quarter. So if you just think about it from a purely guidance perspective, second quarter guidance versus third quarter, we're actually guiding you up guidance to guidance in the third quarter. And then if I could just touch briefly on our longer-term gross margin roadmap, which I know you remember well from both pre-IPO as well as capital markets day. If you recall from those roadshows and from that capital markets day, we put together a pretty specific model and a bridge to go from where we were at the time to our long-term gross margin model of 40%. And from a gross margin perspective, Barring the current utilization headwinds that we're seeing today, we're actually ahead of that model. We're at about mid-80s in terms of utilization, which as you know from a sensitivity perspective, five points of utilization is roughly two points of gross margin. And yet we've been able to actually not only sustain gross margin, but slightly grow it on a year-over-year basis. So with respect to our long-term gross margin roadmap, still on track. Barring the underutilization, actually ahead of schedule. but certainly on track to that long-term gross margin commitment that we had made.

Very helpful. Thank you.

Thank you. One moment for our next question. This question comes from the line of Chris Stanley with Citi. Please proceed.

Hey, thanks, guys. Just another couple questions on the gross margins going forward. Have your pricing assumptions changed at all in the last three months for 2023 slash 2024? And if we keep the mid-50s utilization rate going forward, is there any risk that your inventory becomes too high because it jumped up sequentially? So wouldn't we have to have some sort of lowering of utilization rate going forward?

Sure. So let me address a couple of the points there. Let me start with the ASPs. First, let me reiterate that for the full year 2023, we still expect ASPs to be up slightly year over year. With respect to the second quarter, obviously year over year ASP was down very slightly. That was really driven by a shift in our product mix as our core pricing has remained mostly contractual and unchanged. The mixed shift in our business, it has produced a more accretive adjusted gross margin structure, as you saw with the number that we printed in the second quarter. But on a period basis, that mixed shift did produce a slightly lower ASP year over year. And, you know, the other item I'd like to just talk about briefly before we talk about some of the inventory is that free cash flow. You know, when you look at what we've been able to deliver, both from a gross margin perspective, from cash from operations, and from a capital efficiency perspective, you know, we were able to deliver $146 million of free cash flow in the quarter. The higher gross margin structure combined with that operational productivity and capital efficiency enabled us to produce that number, despite, as you mentioned, some of the inventory growth that we saw on working capital. On the inventory growth, most of that is related to substrates. We have some agreements with some of our suppliers, and some of those agreements include the purchase of substrates, which we've been able to acquire at some favorable prices. Those substrates are good for many years. And as we look through this current inventory perturbation, we look through this cycle, Having the ability in the balance sheet to be able to support acquiring some of what would be for us raw material substrates at some fairly attractive prices, it's a good long-term decision. Did you have a follow-up, Chris?

Yeah, just to talk about the 2024 expectations for pricing. Have you guys changed any of the terms of the LTAs for 2024 over the last three months?

Yeah, so, you know, I won't delve too far deeply into 2024, but with respect to ASPs, look, we still have very good LTA coverage in 2024. And as you know, those contracts are fixed price, fixed volume, fixed duration. About 90% of our design wins are single sourced. And about two-thirds of our revenue today is also single sourced. So, as we look through into, you know, 23, 24, And even into 25, we continue to see it's a relatively constructive pricing environment right now. That's our current expectation.

Thanks.

Thank you. One moment, please. Our next question comes from the line of Joseph Moore of Morgan Stanley. Please proceed.

Great. Thank you. I wonder if you could touch on some of the comments up front about the pace of inventory reduction happening more slowly. I'm not surprised at the characterization that there's still some correction going on, but the idea that it's happening more slowly. Can you talk about what's driving that? Are the LTAs, are there situations where people are taking inventory that they might not take if the LTAs weren't there? And then how much of that is just Maybe there's a permanently higher level of inventory given anxiety about supply chains. Just kind of, you know, what's underlying that comment that you made?

Sure. So, when we think about inventory, and we track it probably along similar lines as you do, Joe, we look at everything from distributor inventory to customer inventory to OEM inventory, and then, of course, to GF as well as our peer inventory. So we look at inventory across a broad spectrum. And so when we say that inventory is depleting more slowly than we are expecting, we're primarily referring to inventory broadly across our customer set as well as across the DSTI and the OEM channels. When we look at that inventory, I think the glass half full view is that that inventory is no longer growing. It looks like it is troughed. And it looks like the inventory is continuing to deplete now from this point going forward. We did expect that to happen a little earlier in the year, quite frankly. And it looks like it's pushed out. And so now we're no longer growing inventory in those channels that I just mentioned. But they haven't yet, you know, materially come down. And so that's pushed things to the right throughout 2023. So we expect that inventory to come down in the second half. Now, in terms of why the inventory is currently where it is and what was the driver of it, it really is dependent on in-market. I think there are some in-markets that structurally will just carry higher inventory levels on a go-forward basis because the cost of that inventory is significantly less than their market opportunity loss. And so I think those markets and I think the electrification of the automobile being an area where they still are unable to get enough inventory. And then I think when they do get enough inventory, they'll probably run a little bit heavier than perhaps just in time, which was kind of the traditional route. I think in some other markets like handsets, you know, handsets, we're expecting to decline on a year-over-year basis, total handsets, kind of middish single digits. I think that's a market where perhaps there was a little bit more inventory sold in 2022 than expected, it's carried into 2023. And while there's different areas within that market that are doing better or worse than others, I think that would be an example of the market uptake just taking a little bit longer. Did you have a follow-on, Joe?

Yeah, just on that specific point of the LTAs, you know, are there, I mean, it seems like you're working with customers to ensure that They're not taking inventory that they don't want, but are there situations where that causes the inventory position to be a little stickier?

I'll take that, Dave. I think that's the point. The point is, where do you trade off kind of settling up with an underutilization fee versus taking a little bit more inventory and getting that balance? And that's all part of muting the amplitudes of a cycle like this. You don't want to go down as deep. You want to be more balanced in the peak to trough, but that typically takes the frequency or the time horizon longer. And I don't think anybody's doing anything reckless in taking a lot of inventory not to pay underutilization fees, but it's one of the levers they have, and that collectively we make those judgments together.

And if I could build on that, Tom, let me just maybe talk to a proof point. One of our customers that's in the smart mobile space, actually, when they announced over the last week or so, they actually mentioned GF. They mentioned their LTA with GF. And one of the things that they mentioned was the flexibility that exists within that LTA such that they were able to migrate out of a technology node or a product set that perhaps was not in as much demand to actually a product and add a technology node that was in much more demand where they needed incremental capacity. And so I think that's a great example of the framework, the LTA framework being incredibly productive because instead of, you know, fixating on one particular product or one particular variable of the engagement, we were able to sit down, have a discussion, identify areas where there were still market opportunities, shift production and capacity, to satisfy those for the customer, which ultimately helps them fulfill their LTA obligation in a much more comprehensive and collaborative way.

Very helpful. Thank you.

Thank you. One moment, please. Our next question comes from the line of Vivek Arya with B of A Securities. Please proceed.

Thanks for the question. For my first one, I just wanted to clarify, could you give us a sense of which end markets in Q3 could be up or down sequentially? And then as I look into Q4, I think your comments suggest sequential growth into Q4. And again, I'm curious what end markets would drive that given the inventory situation in some of your consumer and comms markets.

Thanks for the question, Vivek. I think I'll pass this over to Niels to maybe provide some color on two of the end markets in particular that not only grew in the second quarter, but that we expect to continue to support our enterprise revenue well into the second half, both automotive and home and industrial IoT. Niels, do you want to provide some commentary on those?

I could go a little bit deeper on maybe starting with automotive and maybe addressing it in three ways. First, actuals this year, our expectations for 2023, but also maybe talk a little bit about our long-term expectations. So, So as of today, you know, we're servicing demand, you know, from D-WINs that we had over the recent years. You can see from the numbers that we did approximately $425 million in automotive in the first half, and we had a close to $250 million run rate in second quarter. And we're expecting sequential growth in third quarter, so We talked about you in previous calls achieving $1 billion this year, and we feel confident that we will do that in 2023. So in terms of looking at the future and the long-term growth, if you look at the silicon content in automotive, it's expected to grow about six times as you move from ice to ACE, as Tom mentioned earlier. You know, and I is about $300 an average to age two to $3,000 an average. So a substantial growth in silicon content. And when you look at that silicon content, what I think is really important to highlight is that it's essential chip technologies that we have at Global Farmer East, they're a great fit for this. And I'd like to talk just to mention a few of them, because I think, you know, the diversity and the broadness that you have of our technologies really talks to this long-term opportunity in a very good way. Some examples could be high-performance millimeter wafer radars or high-dynamic range processors for the imaging sensing. Both of these two technologies are crucial to get good autonomous performance in the cars as we move forward. Low power, nonvolatile memories for the MCUs, domain controllers, aggregators. We have a very comprehensive power portfolio. that supports both the body control, LED lighting, battery management system, onboard charging, traction inverters. Then lastly, strong CMOS for the networking, CAN, LIN, video, audio, and cluster segments of the cars. So really, for us, it looks like a very, very broad future here. And we feel good about where we're going with the technologies longer term. You know, with regards to longer term, we also continue to strengthen our partnership. You know, GM exclusive production capacity that we announced in February 23 is a good example on that. And so really based on these partnerships and the deviance we have, we expect this business to more than double in the second half of this decade. So that will be a little bit of, you know, more content around our automotive position.

Maybe just to round that out for you, Vivek, I think what you heard was you heard automotive has grown sequentially for us nicely, also year over year. We're expecting that to continue to get to that kind of billion-dollar revenue estimate that we had forecasted for the year. Home and industrial IoT, we're expecting it, obviously, on a sequential basis. We're expecting it to continue to perform well. Smart mobile devices, you know, we had some nice growth sequentially from first quarter to second quarter, but we're kind of expecting to kind of bump around this level as we deplete inventory towards the end of the year. And that's probably a true statement, not only for the third quarter for smart mobile devices, but throughout the year. And then both comms infrastructure and data center and PC. We expect them, obviously, to then fill in the gap to the revenue guidance that we provided for third quarter and the full year. So that's how we think about it.

And then the one thing I'll pile on, if you don't mind, is aerospace and defense. We see that foundry portion of that market growing by the end of the decade to about two and a half billion dollars. And there's no reason we shouldn't get, you know, my quote-unquote, our fair share or disproportionate share in that market. And we intend to go do that. And, you know, part of the announcement in 2Q with Lockheed Martin is about going after them. Lockheed Martin announced that they acquired a design team, so now they can make their own ASICs. And they want a foundry partner, so who do they select? Global foundries. So A&D, a lot like automotive. It's you win sockets. They take many years to ramp in production, but they stick around many years. So a strategic play in A&D feels a lot like our strategic play we kicked off three, four years ago in automotive to get to a growth engine. So stay tuned on that front.

Vivek, did you have a follow-up?

Yes, please. Thank you. On pricing, I think from what I heard, it seems there is somewhat of a positive bias in the second half, and I'm curious what's um driving that uh and and i think as as we look forward um i know you're not giving specific 24 or 25 outlook uh but um do your lta suggest the pricing trend to be up down flat as we look over the next few years sure so we've we've stated you know really for a long time uh that our expectation is that uh pricing in 23 again i'm talking about the full year 2023

we're expecting pricing to be up slightly from 2022. You know, what you're hearing from us today is that we continue to expect that to occur, and that's our current forecast, and we feel quite good about that. And so, you know, kind of some product mix period by period aside, which will always make the decision to move to accretive product mix if it's accretive to gross margin versus purely focusing on ASPs. But from a global statement, with full year ASP in 23, we expect to be up slightly from 2022. With respect to pricing longer term, you know, I think what you've seen happen is, one, you've seen customers sign a lot of LTAs, and as we've spoken about, those have fixed price, fixed volume, fixed duration. That pricing is very solid. I also think, more broadly speaking, that you've seen the industry put on new capacity and the economic models to support putting on new capacity require the higher ASPs and the ASPs to be quite sticky at those levels. And so that's not only a GF statement, that's kind of an industry statement. And so based on both the LTAs as well as the incremental capacity that's been added, We're expecting ASPs to be quite stable and to be in a pretty conducive environment to have stable ASPs through 2024. Thank you.

Thank you. One moment, please. Our next question comes from the line of Harlan Surr with JP Morgan. Please proceed.

Yeah, good morning, guys. Thanks for taking my question. Maybe following up on Vivek. So on your outlook for full year wait for pricing, you mentioned blended average pricing, right, flat to slightly up. But on a like for like, is pricing up better than that? Just want to make sure that the team is maintaining its fairly strong pricing power profile.

Sure. Let me perhaps be a little bit more specific. And it depends on the period that you're looking at when you look back into 2022. As we've spoken about before, and I know you know, Harlan, you know, we put on a pretty fair amount of capacity in 2022. And with that incremental capacity came the ramp of specific LTAs, and those LTAs ramped at higher prices. And so when you really look at the pricing for the second half of 22, versus the pricing in 23, that pricing is relatively flat year over year. But when you look at the pricing in the first half of 2022 versus 2023, that pricing, particularly in first quarter, was significantly lower. And so the ramp of pricing was really tied with the capacity and the ramp of the LTAs. And so the short answer to your question is on a like for like basis, As those LTAs kicked in, pricing's very flat. I think on a year over year basis from a full year blended effect, you're going to see a slight increase full year ASP in 22 versus 23. Hopefully that answered the question. Did you have a follow on?

Yeah, I did. So your large secure smart card access business and RFID tagging business, right? That appears to be holding up relatively strong here through second half of the year. And I think you and your large customer are now able to sort of redirect their way for starts to support the backlog of demand that I think was unmet in this segment over the prior three years. I assume other of your customers are able to redirect their way for starts to product segments where capacity has been tight until just recently, right? It's a good reflection, I think, of the product diversity of your customers that's helping to sustain their business, your business. Auto is another good example. Any other good examples of the product diversity helping to backfill some of the areas where there might be some excess customer inventories?

Yeah, so I think that's a really good point. I'll take this one, David. So two pieces. One, you talked about a particular end market, smart cards. Well, the thing about smart cards, it's more than just your credit card when you wave it past a machine, you know, a point of sale for a transaction, you know, touch list. You know, it's now healthcare. It's government security. It's credentials for your car. So it's a broadening market. But the bigger point you make is really important. You have to have two things. You have to have a diversity of technology platforms, and you have to have capacity that you can fund so that you can move for, hey, I need more 40 nanometer embedded memory versus a 55 solution because this customer wants to buy here. We've worked hard and long. on creating that fungibility within fabs and across our global network. And that allows us to respond to some of the lumpiness in these market segments, to some customer moving of their products as they see opportunities. And so you need both the platforms that you can address these markets, and you need the fungible capacity. And that's something we'll continually invest in across our 300 and 200 millimeter fab networks.

And Harlan, to give you some proof points that you're looking for, obviously you mentioned smart card. On the automotive side, we've been able to move some of the comms infrastructure and data center capacity to support more of the automotive business. On the smart mobile device side, we had a customer that actually provided that example for us. I won't mention their name, but you could go back through those notes and look at them mentioning the GFLTA and how they were able to migrate from one product to another. And we have multiple other examples where we've been able to utilize that flexibility that Tom mentioned to be able to not only quickly move on customer demand, but also do it in a very capital efficient way, which is going to help us accelerate our path to free cash flow in the future.

Great. Good insights. Thank you.

Thank you. One moment, please. Our next question comes from the line of Mehdi Hosseini with SIG. Please proceed.

Mehdi Hosseini Yes, thanks for taking my question. The first one, last earning conference call you talked about revenues for 23, flat to down, high single digit. And I'm not asking for Q4 guide, but unless there is a significant improvement on a sequential basis in December, your 23 revenue would come at the low end. Is that a fair read through of what you reported on your guide for September in the context of the whole year?

That is, Mehdi. So what we reiterated was we still believe we'll be down mid to high single digits for the year. And given that we've already kind of posted the first half and guided the third quarter, that would imply that for the fourth quarter, and the full year that we would be at the high end of that year-over-year decline rate.

Sure. And then with the targeted gross margin of 40%, I just want to better understand if this is a gross or net, or in other words, to what extent it includes all the subsidies. And in that context, if there is any update on the CHIPS Act that would impact the gross margin looking into next year. If you take the CapEx, I'll take the chip. Sure.

So when we originally contemplated our long-term gross margin of 40%, what that contemplated was capital intensity of about, on an ongoing basis, steady state basis, if you will, of 20%. And so that, in other words, DNA would be about 20% of the P&L there. I think what you're hearing from us and potentially from others is that um the capital intensity should be slightly offset by some of the you know various government support around the world and so we haven't updated our long-term gross margin model um but the assumptions that went into it were 20 capital intensity tom did you want yeah and part of that and 20 is is a net number and so that's why these co-investments or incentives

by governments around the world, including the U.S., are important. Remember, just for way of context, there's two ways you qualify for incentives. There's the ITC, which is already in flight, which is 25 cents in the dollar for capital investment, semiconductor, and then there's the CHIPS bill, and beginning of, you know, 2022 is the year of creating the need and the program, and 2023 is the year of... vetting applicants and beginning the allocation for execution. But look, for us, nothing's changed. It's not about our capital allocation. It's all about how we approach the market with certainty, durability, and profitability. We will never put capacity on, independent of how many subsidies there are there to help us, if we don't have certainty of demand by our customers. This isn't a game of chasing dollars. This is a game about certainty of demand. And when we add that capacity, we want to do it in durable markets, markets that we talked about earlier today that have long view into the future instability, and then, of course, profitability. We're not going to invest if we can't get competitive returns on investment. Now, bills like the CHIPS Act and ITC help close that economic equation, which helps, but if there's no demand, there's no reason to leverage all that. So the key here is to get customers engaged lined up to leverage that capacity we could put on for their products for their needs over the longer term, and then use government incentives to create that capacity in our global footprint.

And Mehdi, let me just provide you an additional contextual point related specifically to CHIPS Act, specifically to the ITC. So in 2022, in the US, we believe that we've got about $450 million of investment that qualifies for the ITC. That would imply at about 25% rate, that would imply something like about $120 million of potential benefit on that $450 million of qualified investment. And so the way that would flow through the P&L, if you assumed a steady state 10-year depreciation, the $450 million of investment would be DNA of about $45 million a year, but you would net out the $120 million benefit. And so instead of being $45 million a year hitting the P&L, you'd get something more like $33 million a year that would hit the P&L. So that would be a real-life proof point, both of the benefit from ITC as well as how it would flow to the P&L.

Okay, good. Thanks for the details. Kathy, we'll take one more question. Thank you.

All right. Thank you. One moment for our last question. This question comes from the line of Krish Sankar with TD Cohen. Please proceed.

Yeah, thanks for taking my question. I have two of them. Dave, you mentioned about ASPs down 1% in June quarter, year-over-year, mainly due to product mix. I'm just wondering how to think about ASP trends within your different verticals like smart mobile, IoT, auto, et cetera, and given the fact that you do seem to have a positive bias in ASPs into next year, Should that makeshift change into next year? I'm going to add a follow-up.

Sure, sure. I think, broadly speaking, ASPs are primarily predicated on how much GF kind of differentiated technology and content is kind of included in the product set or the solution. So you could go literally within any in-market and you could find products that either average you up or average you down with respect to pure ASP. What we really focus on is we really focus on the product mix that is most accretive to us from a profitability perspective. And while globally, I think you could probably make a statement like on average comms infrastructure and data center on average, probably has a slightly higher ASP than maybe an end market like automotive. Obviously, you've seen comm infrastructure and data center kind of decline for us, given some of the inventory challenges in that particular end market. And you've seen automotive grow in a really meaningful way globally, probably a slightly lower ASP, but yet you've seen us accrete from a gross margin perspective. I think in general, ASP largely tied to how much, you know, total content is in the solution. Does it have non-volatile memory? Does it have BCD? Is it on a, you know, FDX or an SOI type of wafer? So I think, you know, obviously that plays an important role, but an even more important role is the product accretiveness from a gross margin perspective.

Got it, got it. Thanks. Yeah, I had a quick follow-up. How much of your 2024 capacity

Yes, so with respect to 2024 capacity, let me provide some brief context. Originally, we committed that we were going to increase our capacity from about 2 million wafers in 2020 to about 2.4 million wafers in 2021, to about 2.6 million wafers in 2022, to about 2.8 million wafers this year to north of 3 million wafers in 2024. We're very much on track to deliver on that plan, although obviously we've slowed some of the installation of that capacity based on some of the well-known challenges with respect to channel inventory in the market. If you go back to our Capital Markets Day presentation, you'll see how much of that capacity plan was reflected and covered by LTAs, and I would say that we're still largely consistent with what we showed at Capital Markets Day.

Thanks, Steve.

All right. Thanks, Kathy. Appreciate it. And thank you, everyone, for joining the call today.

This concludes today's conference call. Thanks for participating. You may now disconnect.