Wolfspeed, Inc. (WOLF) Q3 2020 Earnings Call Transcript

Ladies and gentlemen, thank you for standing by and welcome to the Cree Third Quarter Fiscal Year 2020 Earnings Conference Call. At this time, all lines are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. Please be advised that today's conference may be recorded. I would now like to hand the conference over to your speaker today, Tyler Gronbach, Vice President of Investor Relations. Thank you. Please go ahead, sir.

Thank you and good afternoon, everyone. Welcome to Cree's third quarter fiscal 2020 conference call. Today, Cree's CEO, Gregg Lowe; and Cree's CFO, Neill Reynolds will report on the results for the third quarter of fiscal year 2020 and to discuss current circumstances related to the Covid-19 outbreak. Please note that we will be presenting non-GAAP financial results during today's call, which is consistent with how management measures Cree's results internally. Non-GAAP results are not in accordance with GAAP and may not be comparable to non-GAAP information provided by other companies. Non-GAAP information should be considered a supplement to and not a substitute for financial statements prepared in accordance with GAAP. Reconciliation to the most directly comparable GAAP measures is in our press release and posted in the Investor Relations section of our website along with a historical summary of other key metrics. Today's discussion includes forward-looking statements about our business outlook and we may make other forward-looking statements during the call. Such forward-looking statements are subject to numerous risks and uncertainties. Our press release today and the SEC filings noted in the release mention important factors that could cause actual results to differ materially including risks related to the spreading impact of a Covid-19 pandemic. During the Q&A session, we would ask that you limit yourself to one question and one follow-up so that we can accommodate as many questions as possible during today's call. If you have any additional questions, please feel free to contact us after the call. And now, I'd like to turn the call over to Gregg.

Thank you, Tyler. And good afternoon, everyone. And thank you for joining us today. Before we get started, our thoughts go out to those affected by Covid-19 and to those working on the front line to keep us safe during this pandemic. I'd also like to give a heartfelt thank you to all Cree employees for their extraordinary efforts. I've been working at our headquarters here in North Carolina since the beginning of the outbreak to do my day job and also help out in the mornings and the afternoons with our health screening process as people arrive on campus for their shifts. I cannot express enough how proud I am of our people for their dedication to keeping our business running and serving our customers during this difficult time. Our manufacturing facilities in the US continue to operate as essential businesses. And we are closely monitoring the guidelines from local, state, and federal officials. While the Covid-19 situation is rapidly evolving, we remain steadfast in our commitment to the following key priorities. First, the health and safety of our employees, customers, and partners remains our highest priority. We have instituted stringent safety measures, including robust screening, social distancing, and cleaning protocols in all of our facilities. We also have deferred all business travel and instituted work-from-home policies whenever feasible to protect our people as well as the partners we interact with. Second, we are focused on maintaining business continuity across our global operations. To that end, we have implemented plans to ensure we can continue to deliver for our customers while managing our diverse supply chain. Our sales teams have embraced the use of digital platform and remain in constant contact with our customers and partners along with our dedicated engineering and support staff. Lastly, we are working hard to ensure that when this crisis subsides, we will be ready to emerge as an even stronger business and well poised to capitalize on the long-term opportunities for silicon carbide. We continue to believe that we stand before a multi-decade growth opportunity for silicon carbide adoption and remain committed to investing in our capacity to meet this long-term demand. Importantly, many of our customers have indicated that their long-term plans remain in place, including our long-term wafer supply agreements, the delivery of electric vehicles to the market, and the rollout of 5G. We are recognized as a valued partner in these endeavors and continue to receive strong validation for our technology from our diverse customer base. I'll now turn it over to Neill who will provide an overview of our results from the third quarter of fiscal 2020 and an outlook for Q4. Neill?

Thank you, Gregg. Overall, our third quarter performance was negatively impacted by softening global demand and some disruptions to our manufacturing operations arising from the Covid-19 pandemic. In line with our pre-announcement issued earlier this month, revenues for the third quarter of fiscal 2020 were $216 million, a decrease of 21% year-over-year. Our LED segment revenue decreased 23% year-over-year largely driven by the slowdown of the Chinese economy in light of the Covid-19 outbreak and associated disruption to our manufacturing facilities. While Wolfspeed revenue declined 19% year-over-year due to ongoing weakness in power and RF device sales and a temporary shutdown of our Morgan Hill facility. Our non-GAAP net loss was $16 million or $0.14 per diluted share. Our third quarter non-GAAP earnings exclude $46 million of expense net of tax or $0.43 per diluted share for non-cash stock-based compensation, acquired intangibles amortization, accretion on our convertible notes transformation and transaction-related costs, factory optimization restructuring costs, and other items outlined in today's earnings release. Let's review our third quarter performance by segment. Wolfspeed quarterly revenue declined year-over-year and sequentially to $114 million. It is primarily due to ongoing softness in our power and RF businesses that have been negatively impacted by the lower China EV demand and slower than anticipated 5G base station appointments outside of China. In our Power business, in the near-term, we expect Covid-19 to impact our customers' operations as overall auto sales will be weaker in calendar 2020, but our customers tell us they remain committed to their EV investments and are planning to maintain their original ramp schedules. Additionally, despite the uncertainty, we are currently seeing a strengthening in our backlog related to both power and RF customers. However, we remain cautious in our outlook as it is not yet clear how the pandemic will impact customer demand in the coming quarters. In our RF business, our third quarter performance was negatively impacted by a temporary shutdown of our Morgan Hill facility. The facility was closed for approximately two weeks in March to comply with county guidelines prior to receiving an essential business designation from the state of California. The Morgan Hill facility resumed its operations on March 30th following the implementation of several measures prior to reopening to ensure employee safety. In 5G, we continue to be impacted by ongoing delays in peak and infrastructure rollouts, while there continues to be significant uncertainty in these markets. Customers who want to leverage the higher frequencies and higher efficiency output possible from GaN silicon carbide solutions for their 5G infrastructure products are very interested in our technology. Overall, the situation remains very fluid and as I mentioned earlier, we are encouraged to see early indications of improving demand for our products despite overall near-term headwinds. Our materials business continues to be fortified by our strategic long-term agreements and the business performed as expected in the quarter. Looking ahead, while we are seeing some normal variation within the confines of these agreements, we will see a decline in revenue in the short term as one non-semiconductor customer was not designated as an essential business and is not operating at this time. We have stopped shipping to them, which will cause revenue to decline in Q4. Wolfspeed gross margin was 40%. The year-over-year and sequential decline were primarily driven by lower utilization caused by the factory shutdown in Morgan Hill and by lower than expected yields related to the ramp of our 150 millimeter MOSFET product. LED product revenue was $102 million and decreased 15% sequentially. While the third quarter is usually seasonally weak, this was further amplified by the extended Lunar New Year holiday in China and subsequent global developments in response to Covid-19. Positively, we have started to see a recovery in LED demand and we are encouraged by the improving order flow in the first few weeks of the fourth quarter. Even though we expect the Covid-19 crisis to have a lingering effect on some customers. LED gross margin was 20%, primarily due to lower factory utilization given the extended shutdown of our Chinese operations. An allocated cost of $2 million for the third quarter of fiscal 2020 is included in our overall cost to reconcile the $64 million non-GAAP gross profit and 29.8% gross margin for the company. Non-GAAP operating expenses for Q3 were $86 million and our non-GAAP tax rate was 19%. In light of the ongoing Covid-19 situation, we are managing our operating expenses prudently, optimizing what needs to be done now to support future growth while deferring non-essential costs. Now, I'd like to take a moment to discuss our balance sheet strength and ample liquidity, which we believe provides us the necessary flexibility to navigate the current environment, support our business operations, and maintain our capital expenditure plans to support future growth. We ended the quarter with $853 million in cash and short-term investments, a zero balance on our line of credit, and convertible debt with a total face value of $575 million. For the third quarter, day sales outstanding came in at 53 days and inventory days on hand were 99 days. Cash used in operations was $28 million and capital expenditures were $70 million in the third quarter, resulting in a negative free cash flow of $98 million. For fiscal 2020, we are now targeting CapEx of approximately $240 million, a slight increase from what we have communicated previously, which reflects the purchase of some tools at favorable pricing that will be used as part of our capacity expansion. While near-term market conditions are fluid, we haven't seen any changes in the long-term outlook at this time, which is why our long-term strategy to increase our silicon carbide capacity and related capital expenditure plans remain intact. Having our new New York Mohawk Valley fab up and running by 2022 and expanding our materials factory in Durham, North Carolina is critically important to deliver on our customer commitments and win additional business currently in the pipeline. Considering the uncertainty surrounding the Covid-19 pandemic, we elected to maximize our financial flexibility with our successful convertible notes offering completed earlier this month. We decided to take advantage of favorable market conditions to derisk all possible scenarios by securing extra capital to ensure we can meet our commitments regardless of the timing, pace, and duration of recovery post-Covid-19. Importantly, our new convertible debt structure lowers and extends our maturities after a period of heavy CapEx investments in our Mohawk Valley fab and Durham materials factory. Now, turning to our outlook. While we expect the Covid-19 crisis will continue to adversely affect our performance this quarter, it remains difficult to fully evaluate its impact on the overall demand environment and our manufacturing operations. To account for this heightened level of uncertainty, we're providing a wider than usual guidance range for the fourth quarter of fiscal 2020 based on what we know today. We're targeting revenue in a range of $185 million to $215 million based on the following segments trends. Wolfspeed revenue is expected to be between $100 million and $115 million. While the underlying demand for our power and RF devices is improving, we continue to navigate near-term headwinds, including the impact of Covid-19 related to more stringent safety measures that we implemented to protect our employees, which will lower factory utilization and productivity. LED revenue is expected to be between $85 million and $100 million, mainly due to supply constraints. We target Cree's Q4 non-GAAP gross margin to be between 25% and 28% based on the following segments trends. We target Wolfspeed's gross margin to be approximately 33% to 35%, mainly reflecting lower factory utilization and productivity due to the safety measures that I just mentioned. As previously discussed, we are also still experiencing lower than expected yields on the 150 millimeter MOSFET product line which has not yet fully returned to expected levels. We target LED gross margin to be approximately 19% to 21% due to lower volumes. We are targeting GAAP operating expenses to range between $83 million and $84 million as we continue to prudently manage our costs while executing our planned investments in our Wolfspeed business, preparing products for production on our Mohawk Valley fab which we plan to ramp in 2022. We target Q4 non-GAAP operating loss to be between $23 million and $38 million, and we target non-operating income to be approximately $1 million. We expect our non-GAAP effective tax rate to be approximately 30%. We're targeting Q4 non-GAAP net loss to be between $25 million and $16 million or a loss between $0.23 and $0.15 per diluted share. Our non-GAAP EPS target excludes acquired intangibles amortization, non-cash stock-based compensation, and gain on debt extinguishment, accretion on our convertible notes; transformation and transaction-related costs, factory optimization restructuring costs, and other items. Our Q4 targets are based on several factors that could vary greatly including the situation with Covid-19, overall demand, product mix, factory productivity, and the competitive environment. With that, I will now turn the discussion back to Gregg.

Thanks, Neill. Picking up on what Neill was just talking about, I'd like to provide additional color on the latest trends we're seeing as we navigate the near-term environment. While we cannot predict when Covid-19 will start to subside, we expect to maintain the health measures that we have put in place for the next several months. We are also planning to stagger the return of those employees working from home and don't expect to be back to a more normal operating environment until sometime late this summer. This measured cautious approach is being done to help protect the safety of our people. Our more stringent safety measures coupled with the overall operating environment will present some challenges for us in the near term, but we believe the long-term demand remains robust. As we previously mentioned, we're expecting decisions on a significant portion of our roughly $9 billion pipeline in the coming 12 months. As we remain closely engaged with our customers, we are very encouraged by the positive sentiment we're hearing from them, with many of them reconfirming the need for silicon carbide technology. We've also been extremely pleased with how our teams have quickly adapted to the current environment, embracing the use of digital platforms to pursue and win business. The level of engagement is impressive, with meetings on our digital collaboration hub totaling more than 1,000 a day, conference calls up fourfold, and sales pitches per week of seven times in the last five weeks. This has led to increased sales productivity as our sales team has secured more than 500 designs and awards totaling approximately $400 million in the quarter. We also continue to identify attractive design opportunities and projects at a similar pace as in the prior quarters. This connects nicely with the work we're also doing with Arrow Electronics to build a silicon carbide pipeline, leveraging their massive digital sales footprint. Arrow's digital media operations are the world's largest, connecting up to 80% of the global engineering community through 30-plus media sites that attract 15 million monthly users and generate more than 50 million page views per month. Additionally, we recently announced with Arrow the release of our new 650 volt silicon carbide MOSFET that will deliver higher efficiency for a wide range of industrial applications and help foster the next generation of onboard electric vehicle charging, data centers, energy storage solutions to reshape our cloud and renewable energy infrastructures. This partnership is helping drive the transition from traditional silicon to silicon carbide in the power electronics market, and the initial feedback on this new product launch is very encouraging. We also remain encouraged by the tremendous opportunity and recent development in the electric vehicle market, which makes up about half of our pipeline. The most recent report from Goldman Sachs suggests a 4x increase in the total number of EVs sold in 2025 versus 2019, and that silicon carbide can be a crucial enabling technology given the cost and range benefits at the system level. Aside from these considerations, there's also been considerable discussion about how the stay-at-home orders around the world have significantly reduced pollution in many major urban markets. This could be another catalyst for easy adoption as countries look to reduce automotive CO2 emissions. For example, several environmental ministers from EU countries have circulated an open letter recommending that any Covid-19 stimulus package must have a green component specifically referencing sustainable mobility. If such a measure is enacted, it could accelerate or increase the demand for EVs in that region. Further, we've been maintaining an ongoing dialogue with our customers to support them through this tough crisis. While our automotive customers are addressing near-term challenges including some temporary shutdowns of their operations due to the outbreak, most have indicated they remain committed to delivering electric vehicles to the market with silicon carbide on their original timelines. Additionally, design activity for the longer-term programs remains very robust. In 5G, rollouts continue to be delayed, but the current crisis has underscored the critical need for strong communications infrastructure and expanded bandwidth. While some countries have delayed 5G frequency auctions in the near term, we firmly believe the global implementation of 5G capabilities is forthcoming and we are well-positioned to support this transition. Importantly, our pipeline is extremely diversified across automotive, communications, aerospace and defense, energy, and many other end markets. We are continuously growing our product portfolio as we release new products, we are further expanding the possibilities for us across industries and markets. Lastly, we have a number of long-term material supply agreements in place and are well positioned to continue winning new device business. While we are currently navigating a difficult short-term operating environment like all other businesses, our long-term strategy remains intact. Maintaining our capital expenditure plan underscores our confidence in our vision and ability to emerge as an even stronger business well positioned to capitalize on the long-term opportunities for silicon carbide. We have an experienced leadership team that has implemented rigorous business continuity plans allowing us to effectively balance employee safety with meeting the needs of our customers. Our financial position remains strong with a healthy balance sheet and ample liquidity to fund our current operations and invest for future growth. Our market-leading position is grounded in more than 30 years of experience, and we firmly believe we are best positioned to lead the market as we drive the transition to silicon carbide and build long-term shareholder value. With that, I'll turn it back over to the operator and we'll begin our Q&A session.

Our first question comes from Jed Dorsheimer with Canaccord Genuity. Your line is open.

Hi. Thanks for taking my questions. I just wanted to follow up. I guess, first one, I know this is always hard, but have you analyzed the business to see to better quantify the impact of Covid-19 on Wolfspeed? In other words, if you didn't have that, how should we be thinking about fab load in that business if that's a fair way to assess?

Yes. Maybe I'll kick it off and then Neill can give you a little bit more detail. I think, Jed, certainly there's been an impact. You heard we've had our Morgan Hill facility which shut down for two weeks. We've got new protocols in place that are taking productivity basically out of our manufacturing plants. Some of those protocols, as an example, I'll give you one example, are bringing people into our wafer fab in staggered shifts. So what would normally be a 10-minute shift change now takes an hour. And we have two 12-hour shifts a day, so twice a day where we're spending an hour each time for two hours out of 24 changing shifts, if you will. This is substantially helping us from a protocol perspective inside of our North Carolina. We've had just a couple of cases of Covid from our employees, but we've had no further transmission across the rest of the employee base here. And so obviously these protocols are working well. Neill talked about the strengthening of the bookings that we're seeing both in power and in our app, and so I think it goes without standing that this is definitely having an impact on how our serve has had an impact on it. So I'll turn it over to Neill for a little bit more color on that.

Yes. I think that's right, Gregg. I mean if you look at 3Q for Wolfspeed, I think the quarter, while the revenue was down, it largely played out as we kind of had expected when we gave the guidance last quarter. I thought Gregg had mentioned that we got to shut down in Morgan Hill for approximately two weeks at the end of the quarter. So if you look at the change versus our original guidance in 3Q, it was Covid-related and it was really related to the Morgan Hill facility; everything else, I would say, turned out as planned. As you look forward, and Gregg talked about it, the order book actually picked up and we're seeing it strengthen. So the lower revenue in 4Q isn't really a function of the order book as much as it is the factories and the safety protocols that we put in place that are driving lower productivity. So we have the designated and essential business for all of our US factories, so they are open, but the protocols are putting some stress on the system in terms of output. And we'll just have to manage through that as we go forward.

Got it. That's a helpful. Thanks. And then as my follow up, I was wondering if you can talk strategically, Gregg, if we think about the GaN on silicon business for 5G, it's unlikely that we're going to see, I mean, hopefully we see some trade resolution, but it seems somewhat unlikely at this point. The stress test from Covid would suggest, as you were alluded to in the prepared remarks, is a potential catalyst for infrastructure build-out. I was wondering if you could just elaborate on how you're thinking about the GaN business for, well not GaN on silicon but the GaN on silicon carbide then began business for next year. How should we be thinking about that as expectations have largely been taken down to pretty low levels as a function of the Huawei trade issues.

Yes. And we don't anticipate that particular item resolving anytime soon. So recall in our Investor Day we've said that we have a nice opportunity across China, but in terms of the long-term plan we have less than 10% of our revenue in 2025 is overall China related, and none of it is Huawei related as we just don't see any kind of path towards closure on that. I think most of the rest of the world has slowed down the deployments. There's been delays in the licensing of the various different frequency spectrums and so forth, primarily because a lot of these companies are either shut down or in some kind of constrained environment and so forth, but I think as we said, this work-from-home situation that's kind of run across the board here is certainly showing a need for an increase in bandwidth. And we feel real good about the long-term prospects here. And obviously that would be without Huawei.

Hey, guys. Thanks for taking the questions. Hope everyone is doing well. I had two questions on gross margins. Just the first one is maybe a bit more near-term focused on the 33% to 35% guidance for Wolfspeed for Q4. I know, you talked about some of the new protocols in place, but if you could quantify a bit more for us just bridging from the 40% you reported in Q3. It sounded like that already had some Covid impacts embedded there, but there's a five percentage decline in revenues. You got the midpoint for a Wolfspeed, but then a 600 basis point decline in margins. It doesn't seem like it's all volume. I don't know if it's all the new protocols and maybe lack of productivity, but if you could just kind of walk us through a couple of pieces here, that’s a pretty meaningful Q-on-Q decline in margins. I know you had talked about scrap issues and utilization, but just with all that's going on maybe if you can kind of help bridge a little bit between the 40% and the new guidance here for Q4. And then I had a follow up.

Yes. Thanks Brian. This is Neill. I'll take a shot at that one. And first of all, I think it is primarily volume related. I think Gregg could probably give you a number of things we're doing in the factory that kind of will explain that. Let me just kind of walk you through the pieces here. So, first of all, as you mentioned, the Wolfspeed gross margin will decline. The lower gross margin, I think, like revenue is driven by the lower factory productivity and the utilization. So again, while we've been designated as essential businesses and we put a number of safety measures in place for our employees, these are going to lower the utilization levels and that kind of drive down the gross margin. Now the second thing is we continue to make progress on 150 millimeter MOSFET yields, however, as it relates to the volumes going through the factory, that at the labs and those types of things, I think the progress on that has been muted a little bit. So have to think through that. So as we move forward, I think there's a couple of factors to consider here. And the first relates to how we manage the safety procedures that we've got in place right now. And regardless of what the government outcome is and Gregg mentioned in the prepared remarks, we kind of expected those gross margins to be somewhat muted for a period of time, also to get back to normal levels. And I talked again about the 150 millimeter challenges that we've got as time moves forward. I would expect though as volumes come back as eventually when we get back to more kind of a normal operating rhythm, we'd see them come back after that and normalize basis as we had been talking about previously, but those are going to have a pretty substantial impact on the business in the near term.

To provide some additional context, on a typical day, our factories are operating with about 45% to 65% of the regular workforce, which of course affects our output. We have been strongly encouraging employees who are unwell to remain at home. As a result, those who would usually work through minor illnesses are staying home, which is beneficial as it helps limit the spread of the disease. Additionally, some employees are absent due to being at higher risk, such as those with diabetes or respiratory issues, while others are caring for elderly family members. We are hiring replacements for those who are absent, but we are doing so cautiously to avoid overwhelming our current workforce with new employees who may not yet be trained to operate our equipment. We are focusing on bringing in experienced individuals to train others. Recently, I met a new employee who started and is already getting acquainted with the machinery. While there are many factors influencing our situation, the overall efforts are positively impacting our ability to control the spread of the disease, though they are certainly affecting our utilization.

Okay. Yes, fair enough. That's all very helpful. Maybe moving to more of a longer-term question because hopefully all of this does normalize sooner rather than later, but as we think about the longer-term margin targets, I would assume they're not changed here, but how should we think about some of them mix implications as the $9 billion device pipeline as you start to see more of the mix of power devices in sales? What are the margins or I guess the implications of margins from that increasing mix? Reason I asked being if you look at other power semis categories, those peers tend to have margins that are more in the 30s and 40s and you guys are obviously targeting a much higher margin profile in the long-term timeframe. So just wondering how the increasing mix of silicon carbide power devices should impact the Wolfspeed gross margins and why they'd be higher there traditional power semis, if that's your view. Thanks guys.

Okay. Yes, maybe I'll kick it off and then turn it over to Neill for some additional color and so forth. I guess what I would say is, number one, our long-term view and the goal that we have of running this business north of 50% hasn't changed at all. I think we've got pretty good line of sight to get there and we've got a pretty solid plan in place. That is, I don't say mix independent, but all three of the businesses are targeting at that or higher margin. So the mix over a longer period of time shouldn't be an issue. Obviously in the near term, we've got all of these issues that we're dealing with, but it really hasn't changed the longer-term target. Maybe I'll hand it over to Neill for a little bit more color.

Yes, and I think the other thing is we've talked about it before, we've got a nice scale opportunity in the materials business, I think which fortifies us from a margin standpoint. I think the second piece is we've got relatively inefficient factories even on kind of a normal operating cadence down in North Carolina. So when we get to the Mohawk Valley fab that starts to come back together. As I've said before, we've got a pretty good line of sight to that. We've got some long-term agreements. We understand that pricing and we've got pretty good line-of-sight to what the Mohawk Valley costs are going to be, so we put those things together and I think the long-term margin profile both from a pricing standpoint for what wins in the market and for what we think that cost space is going to be pretty well understood.

And then the final thing may I just add in there is that everybody knows silicon carbide substrates are more expensive than silicon substrates. And we're obviously driving pretty substantial cost reductions on both the substrate and the epitaxial layer on top of that but the substrate as a percentage of COGS for a power semiconductor chip that silicon carbide is going to be more weighted towards the substrate. So as we have our own internal operations on that, I think we can see some upside there.

Yes. Thanks. Question for, Gregg, just on the design and activity that you talked about and especially with the focus on the next 12 months. Can you maybe just talk about instances where you're seeing success and winning? What's kind of leading to that and also in business where you are competing that you're not winning it? What are the kinds of hurdles at this point?

Yes. I could highlight some of that. We just reviewed some of that the other day. So, obviously, this past quarter we had several hundred customers go from opportunity to design in, whether kind of committed to using us and super excited about that. And it's totaling around $400 million. Now, obviously, all of those won't eventually go into production. There's always kind of some percentage of that that goes away, but it's a great indication of success and basically when customers do evaluations of this technology, they look at a number of different things. They look at the device performance. We always come out very much on top when it comes to device performance. They look at the supply capability and obviously, with the expansion that we have in silicon carbide manufacturing capacity, we come out pretty good there too. From our automotive perspectives, they look at your ability in automotive. Here we're coming up the learning curve, I would say on that. And we've added a substantial amount of capability inside of our team in terms of folks that understand automotive that has been a big help in terms of securing things like Delphi and ZF. So as an example, the woman that runs our quality organization used to run automotive quality for a very large semiconductor company focused on automotive. So we're bringing that skill set in. So that's been on the positive side. Obviously, we're not going to win everything. And I don't anticipate that we're going to win everything in our $9 billion pipeline. In fact, we'll probably lose a sizable amount of that at the device level. What I would say is in terms of losses, sometimes it's not having exactly the right part at the right time. There are times where customers are looking for a ramp that's faster than we're able to handle because of our capacity situation where it is today. And so it goes to somebody else at the device level. What I would tell you is that all of the device losses that I've seen have basically gone to folks that we have very good relationships with in terms of materials. So if we don't win at the device, we tend to win it at the material side of things. I don't know if, Neill, you have any additional color you want to put in there.

No. The only thing I would add there, Gregg, is that that's why it's so critical that we get the Mohawk Valley fab up in New York built between now and 2022. I think that really changes our device business from a competitive standpoint and from quality capability and all those other things. And we kind of just talk about it, so that's why we've got to absolutely stay focused on making sure that's kind of our longer-term plan going forward.

Got it. And then just as a follow-up, Neill, you mentioned kind of the OpEx and you kind of measured spending in this environment. How does it play through kind of maybe the next couple of quarters? I know visibility isn't great but just what are some things you're able to kind of curtail and then when did things kind of get back to normal?

Yes. Thanks, Craig. So, look, we're going to be managing things prudently and what that means is we'll look at all the variable type of opportunities in the portfolio incentives and those types of things and any discretionary expenses, obviously we're going to pull back on and manage. And I think you can see that in the outlook we just provided. However, similar to driving our CapEx expenditure over the next couple of years, we're going to have to invest in Wolfspeed, and that means R&D resources to ensure we've got the capability to design and get parts out. It also means to sell the marketing resources to be out there and get feet on the street to be selling our parts. So I think for the near term, I think we'll have a bit of a pullback. But I would expect that OpEx as time goes on to, regardless of the scenario, start to kick back up again as we start to get into 2021.

Thanks a lot. Couple of questions, if I could on RF to begin with. 5G rollout outside of China has never been really particularly stellar, especially in the products that would use GaN. If you look at millimeter wave, etc., and Verizon, they don't use any of it. And now that you don't have Huawei, has the mix moved back toward defense, which you've always been big in? And is it fair to assume that, especially given that you are an essential business that most of the business that you're running, Wolfspeed on the RF side of it is for the defense business at this point? And if you could maybe as a prospect for what you see 5G going without Huawei in the next year or so?

Yes, we still see significant excitement for GaN on silicon carbide in the 5G sector beyond Huawei. We're in contact with most of the key players outside of Huawei, and the response has been positive regarding the technology. We're currently at various stages of design with these companies. In fact, we secured some design-ins last quarter specifically in the RF sector for GaN and silicon carbide. Additionally, we continue to have a strong aerospace and defense business, with active customer engagement in that area. There is a favorable long-term outlook, but I would describe the situation for GaN on silicon carbide outside of Huawei as a promising opportunity. Many customers are assessing the technology and recognizing its advantages, particularly in relation to massive MIMO.

If I could, it sounds like the 150-millimeter MOSFET yields fell below expectations again this period, and this problem has persisted I believe now for three quarters. I was hoping maybe you could put some color on the causes given, and correct me if I'm wrong here, but aren't you in production with that same part in the RTP campus before you duplicate in Durham? Is it a crystal way for an ePi? It sounds like it's a device problem, but I'm just curious, are you sourcing the crystal and the ePi from the same line that was supplying RTP or is it an entirely new line? So the problems could show up in any one of the three steps and that's why it's taking so long to correct? Any color will be helpful.

It is indeed a change in wafer diameter. The RTP factory operates at 100 millimeters, while the Durham factory runs at 150. This shift in diameter is primarily related to the fabrication facilities rather than the underlying technology. As mentioned, we have made progress, and while yields are improving, they are not increasing as quickly as we would like. Part of this issue over the last quarter and into this one is the reduced output from the factory, which limits the amount of learning we can gain regarding yield improvement. I attended our yield review earlier today and saw many positive developments. We are seeing improvements and have plans for further enhancements this quarter, but they are incremental rather than significant leaps. It's important to note that these factories are relatively old, meaning there is limited automation, and making these improvements requires substantial manual effort. When we transition to the Mohawk Valley fab, it will be a highly automated and advanced wafer fabrication facility. Any issues encountered there will be easier to resolve due to the automation and data systems that will enable quicker resolutions.

Hi, good evening, and thanks for taking my question. So, Gregg, the design-in metrics 500 designs, $400 million in revenues are really important and useful metrics to share. So thank you for that. Can you maybe comment how this compares to the preceding couple of quarters? And with COVID-19 out there, have you seen any change in this new business for velocity that you're seeing on the design-in side and duration? Are any of these likely to contribute to short-term revenue or are these things that are likely to contribute over the next few years as we look at the bigger revenue ramp?

Thanks for the question, Craig. The design-in activity and the addition of new programs to the pipeline are continuing at the same pace as before, which is very encouraging. We achieved around 500 design-ins, totaling approximately $400 million this past quarter, which I find impressive, especially considering the lockdown situation. Notably, about 60% of these wins were related to automotive and about 60% were power-related, which makes sense as they are interconnected. We are quite optimistic about this. Regarding the near term versus long term, there hasn't been any change. We still see most projects, particularly in the automotive sector, aligning with timelines for 2022 and 2023, especially with production ramps for Delphi and ZF. The main near-term impact we’ve noticed relates to our customers' access to labs, which can sometimes be affected by shutdowns, potentially extending the evaluation process. However, during calls with various customers, I've asked if they anticipate any delays in ramping up production, and almost universally, they've responded no. In fact, they believe the ramp will likely accelerate as they and their customers increasingly focus on electrification of powertrains, with no intention of reverting to internal combustion engines. Conversations with automotive clients indicate that as they prioritize their R&D, they are focusing more on electric vehicles and putting less emphasis on autonomous vehicles for the time being, as the latter is a longer-term goal. Lastly, it’s noteworthy that people are becoming aware of environmental changes, such as cities like Los Angeles experiencing clear skies and reduced pollution for the first time in years. Young people in various parts of the world are witnessing blue skies for the first time in their lives. Along with the EU's initiative to couple stimulus measures with green recovery, particularly regarding electric charging stations, I believe our automotive customers are recognizing this as a significant opportunity.

Great, thank you for that. My follow-up is on 8-inch. Has your thinking about 8-inch meaning shifted or evolved over the last number of months, given the issues encountered on the scale up on the MOSFET line? Are there lessons that you can take on future scale-up from 150-millimeter? What's your current thinking on 8-inch?

Yes, it hasn't changed at all. We are fully committed to that. Regarding the 100 to 150, it really has nothing to do with the diameter, materials, or the underlying ePi. All of that remains solid. The issue is with a fabrication facility that is somewhat outdated, and our ability to make precise adjustments is limited by the lack of automation. Additionally, this situation coincided with a pandemic, where we have only 45% to 65% of our workforce available, and we are prioritizing materials for our customers. So, to answer your question, there is no change at all in the 8-inch, and we are maintaining our intensity in driving 8-inch as well.

Hello, everybody. Thanks for taking my questions. I have two. The first relates to the way the semiconductor business works. One of the things you can do if demand is soft and you're still trying to ramp is just kind of absorb cost to inventory. So I'm wondering if we might see you perhaps choose to let the inventory go up here for a couple of quarters while we wait for the post-COVID world to catch up? And then I have a follow-up.

Yes. I'll start by noting that our demand book is looking fairly strong; however, securing the buyout has proven to be more challenging for us. This is partly due to COVID-19 and certain deals we are discussing, along with the fact that 45% to 65% of new customers are entering the market. If we could establish an inventory buffer, I believe our customers would be quite enthusiastic about that. I'll let Neill elaborate on our overall inventory strategy.

Yes, I think that's right, Gregg. So overall, this is obviously an unusual situation that we've got in our hands here with the way that the safety protocols are impacting the factories, Joe. So I think that if we get more out and get more inventory through, I think that's exactly what we could do, in fact. One of the areas we're focused on is assurance of supply and making sure the full supply chain is supporting the factory. So while utilization is coming down, I wouldn't say that necessarily by choice, but I think we'll just have to manage through this and should inventories come down a little bit in that case. So be it; we're just going to have to try and manage as best we can through what we've got in front of us right now.

Okay, thanks. That's clear. And then the second question. We spend a lot of time talking about RF, and while we, I'm kind of curious about how the, given all of the trade and political considerations, we're thinking about what the picture looks like for your electric vehicle, your EV power MOSFET business in the Chinese OEMs and what the sort of trajectory of bookings has been there?

We have positive interactions with customers, and there is a shift in China towards longer-range electric vehicles. Most of the electric vehicles in China are currently shorter-range, but they are moving towards producing longer-range models. I met with several customers in late December, and the discussions were very promising. It seems like they are starting to turn plans into production. There is significant interest in silicon carbide technology due to its benefits for vehicle range. However, I want to emphasize that we do not anticipate a quick resolution to the trade issues. Over the past year, there have been numerous updates suggesting imminent resolutions, which did not materialize. Therefore, we are adopting a cautious approach, acknowledging that this will likely remain a challenge for some time. Looking at our long-term outlook, particularly the 2025 plan we discussed at our Investor Day, while we see substantial opportunities in China, our revenue forecast for 2024 indicates less than 10% dependency on Chinese revenue. We are being conservative in our estimates considering the ongoing trade situation.

Great, thanks for taking my questions. I have two. The first one is more related to near-term. You talk about seeing some strengthening demand in Power and RF customers. Can you maybe add some color around what you're seeing there, any particular end market geography that you would point to, or is it just a function of factories reopening and people coming back to work? And are you suggesting that the Wolfspeed revenue would have been up quarter-over-quarter if it weren't for the supply issues impacting the factories' utilization and throughput?

Yes, a couple of things. So near term, things like servers and power supplies for servers in some of the industrial markets that we play in, we're definitely seeing some amount of comeback from that primarily because of what's happening with everyone working from home. We've got customers definitely interested in that. I'll let Neill kind of give a little bit more color on that.

Yes, I think we're seeing certainly across a couple of different areas. So both between industrial energy, there are some automotive applications, actually we go picking up, although those remain relatively small in terms of the book of business we have right now; but we're seeing, I'd say, a relatively broad-based pickup in the business at this time, which is good to see. Would that have given us a higher revenue number in the following quarter? It's hard to say. Based on the backlog, I think that's probably true, but we're happy about the backlog, obviously, but the challenge continues to be getting output to the factories.

Okay, that's helpful. My follow-up question is staying with the Wolfspeed business; can you help us understand how much of your Wolfspeed revenue today, maybe picks a quarter is tied to automotive? And within that, how much is tied to current production volume versus maybe some R&D progress of future production? Just trying to understand what we hear global estimates are coming down when one of the key customers talk about low expectations for the silicon carbide revenue, how does that impact you?

Yes, Neill, please correct me if I'm mistaken, but I believe that regarding power, automotive-related revenue represents a high-single digit to low double-digit percentage of our total. Currently, it's fairly diverse across various customer segments. As we move into the coming years and expand our automotive business, it will obviously grow significantly faster than our other segments and will represent a much larger share of our business by 2024. Right now, it's approximately 10 percent of the revenue in power, which is relatively small. In terms of production versus ramping, most of what we shipped in recent quarters has been production. However, we are observing a growing demand for pre-production runs, prototypes, and similar activities, which we mentioned in earlier calls a couple of quarters ago. Last quarter, customers indicated that they expect a steeper ramp-up in equipment and are therefore looking for more prototypes earlier. Neill, do you want to provide any additional insights on this?

Yes, the only thing is, you know, look, we're talking a lot about the order book, and I think one of the things that we don't know is as it relates to the COVID-19 is how is that going to impact end customer demand three months from now, six months from now. That's one thing we don't know. So I think we're just being a little bit cautious in our outlook despite the strong order book. We're happy to have the strong order book, but again, it's a very fluid and dynamic situation that we're dealing with, and we also continue to monitor that. I think we're seeing what the right levers are to pull, how to kind of manage through this situation that we're in right now, but we're going to have to wait and see in terms of how this kind of pans out and see how the new order backlog kind of fills in as we move between this quarter and next quarter.

Great. Good afternoon, guys. Thanks for taking my question. I know there's been a lot of question on the orders, but maybe just one more. So just to be clear, Neill, you're saying that you have already seen a trough in orders and that things are going to improve from here? And maybe I know someone asked earlier, but I didn't hear the answer, geographically can you give us any kind of color there on what you're seeing from an order perspective geographically?

Thanks, David. I think if you go back to last quarter. And then even through the first two weeks of this quarter, we have seen some strengthening of the backlog in the device businesses. However, I think, as I just had mentioned, I think we're just being a bit cautious about that because we just don't know how it's going to play out and you start deconstructing the backlog into. So it's kind of early ordering or whatever that might be. So we're just taking that a little bit cautious as we start to understand what end market is going to look like. As China is coming back and Asia is coming back a bit, we've seen a little bit of a pickup there; I wouldn't call it big, but we are seeing it from the other regions from a Wolfspeed perspective. So like I said earlier, it's broad-based. I'd say it's both from an industrial energy standpoint as well as automotive; we are seeing a little bit of a pickup, but again it's a dynamic situation. We'll see how it plays out.

Okay, that's quite helpful. Thanks for that. As a follow-up, regarding the 500 wins totaling $400 million that you mentioned earlier, Gregg, were any of these attributed to Arrow? Also, when does the automotive portion come into play in terms of sales? Thanks.

Yes, I don't have the specific details. However, I can tell you that they are consistently doing an excellent job for us. When we launched the 650 volt MOSFET program, which I believe started around April 1 or 2, we have significantly exceeded our goals regarding new opportunities and design-ins. The program has gained momentum quickly. They're performing exceptionally well, and this is crucial for us because we have a relatively small sales presence and are definitely not at scale in sales and application engineering, while they have substantial scale and a strong digital presence. We're very pleased with this. While I would love to provide a specific breakdown, I don’t have that available. I do know that within our distribution channel, they account for a significant percentage of our design wins for the quarter, indicating strong progress.

Thank you. Our next question comes from Paul Coster with JP Morgan. Your line is open.

Yes, thanks for taking my question. Just following up on that last one. I assume that the $400 million, the 500 design wins, this is not part of the $9 billion of the pipeline. This is more kind of earnings type business. Is that a correct statement or is this how we should see the pipeline being kind of whittled down over the course of the next couple of years?

Yes, we have a structured pipeline that follows a common methodology used by many companies. It begins with identifying opportunities, then moves to a design-in phase where customers decide to use our products. The next step is achieving a design win, which happens when we receive the first production order. In the automotive sector, securing a design-in is a crucial metric. While we aim to transition to production, that process typically takes three to four years. Therefore, obtaining design-ins early is vital. I would not categorize any of our design-ins as quick business; they all contribute to our pipeline. Some opportunities may have shorter timelines, such as a power supply for a server, while an industrial motor will take longer, and automotive chips will take even more time, with aerospace projects taking the longest. We constantly see fluctuations in our pipeline, and while not every design-in will lead to production, increasing the number of design-ins is definitely a positive indicator.

Right. Got it. And then maybe this is picking up in the nuance that wasn't actually there, but at one point you said that all of the conversations you've had with the auto industry are confirming their intentions to proceed as planned, but another point you just mentioned that most of the ePi industries proceeding, I'm just wondering if there are any of your potential customers out there that are booking at the prospects of blanking the big CapEx plunge into EVs given the experience that are currently having with COVID-19. In short, do you want to kind of differentiate at all those conversations?

Yes, good observation, Paul. It's quite straightforward. In terms of production, no one is altering their plans or delaying anything by a year. What we’re seeing is that some customers have their labs closed, which restricts their ability to receive our parts, integrate them into inverters, evaluate them, and provide us with feedback. This doesn't mean they are changing their production timelines; rather, their decisions may take a bit longer because of this situation. That's the nuance here, and while this issue hasn’t affected all customers, it has impacted a few. I would expect this evaluation delay to be around one to two months. Some customers actually have their labs open, which is positive. However, all the customers I've spoken with have indicated that their plans remain unchanged, while others simply cannot access their labs. Does that clarify things?

Hi Neill, I wanted to revisit the gross margin in relation to the first question. There are several factors to consider, especially since the impacts of COVID are challenging to predict. My question is about utilization, which is the primary factor, and how incremental revenues translate into margins. Additionally, I was a bit unclear about the comment regarding the strengthening order book; it doesn't seem to indicate that there is enough confidence to suggest that the second quarter of the calendar year would be the lowest point along with utilization.

Thanks, Ambrish. I'm not entirely certain about the specifics regarding the ball-through, mainly because we have a very dynamic portfolio at the moment with numerous moving parts. However, if you examine the margins from the third quarter to the fourth quarter, the variation from that 40% to our midpoint guidance is largely influenced by COVID. This involves various factors, including employee attendance, which ranges from about 45% to 65% on any given day. We've also adjusted compensation for different roles to accommodate varying work demands, and managing the staggered employee schedules adds to the complexity. Therefore, I view the gross margins as closely tied to COVID, and once we return to stable operating conditions, those margins should rebound to their normal levels. Regarding the order book, we have a solid understanding of the backlog, and specifically, the backlogs in the device sectors have improved. However, with the ongoing COVID situation and uncertainties around recovery, it's challenging to predict how those orders will materialize or what the end customer demand will look like in the next couple of months. There is, nonetheless, a clear indication of an improving backlog, which we observed even before the recent escalation of the situation. Overall, while we see some progress in the backlog, we will need to remain adaptable as we navigate the next few months.

Thank you. I'm showing no further questions at this time, I'd like to turn the call back over to Gregg Lowe for closing remarks.

Well, thanks everyone for your interest in Cree. We wish you all the good health during this COVID crisis and look forward to updating you on our next earnings call. Thank you.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.