Wolfspeed, Inc. (WOLF) Q1 2023 Earnings Call Transcript

Hello, and welcome to the Wolfspeed, Incorporated First Quarter Fiscal Year 2023 Earnings Call. My name is Harry, and I'll be your coordinator today. It is now my pleasure to hand you over to Gregg Lowe, CEO, to begin. Please go ahead.

Thank you, operator, and good afternoon, everyone. Welcome to Wolfspeed's First Quarter Fiscal 2023 Conference Call. Today, Wolfspeed's CEO, Gregg Lowe; and Wolfspeed's CFO, Neill Reynolds, will report on the results for the first quarter of fiscal year 2023. Please note that we will be presenting non-GAAP financial results during today's call, which is consistent with how management measures Wolfspeed'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. A 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. 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 impact of the 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.

Thanks, Tyler, and good afternoon, everyone. The growth in demand for our power device product line is greatly outpacing anything we would have anticipated only a year ago. At our last Investor Day, we said Wolfspeed was well positioned to capitalize on the increasing demand for EVs, industrial, and 5G. We described 2022 and 2023 as an inflection point in the adoption of silicon carbide with accelerated growth beginning in 2024. Clearly, adoption is well ahead of schedule, creating an even greater demand-supply mismatch than we had discussed previously. Fiscal Q1 revenue grew 54% year-over-year, our second straight quarter of greater than 50% top line growth when compared to the prior year period. Our device opportunity pipeline has increased to more than $40 billion, more than double the $18 billion that we talked about at our last Investor Day. And our sales team continues to convert this pipeline at an impressive rate, posting another record quarter in Q1 with $3.5 billion of design-ins. Our last four consecutive quarters of design-ins, each of which was a record at the time, totaled approximately $9.3 billion, which is 3.5 times higher than the prior period. We continue to see strong demand for our power devices, with Q1 revenue up more than 120% year-on-year. The team in Durham has done their best to ramp production and expand capacity. But running a manual fab has its limitations, and we are seeing lead times extend for tools and replacement parts for fab equipment, which is impacting our ability to align with customer needs. Lastly, as part of an ongoing effort to expand the supply of silicon carbide, the team was successful in increasing the length of pools through our continuous improvement efforts, which will help drive more wafers going forward to meet the immense demand for silicon carbide substrates. While this will help alleviate some supply constraints, we're still refining some of our back-end processes for the longer poles, and this will impact yield for the next couple of quarters. We're entering a period of significant expansion and experiencing the associated growing pains. When I reflect on where we've come from in the last five years, from a $200 million semiconductor business back in 2017 to a global semiconductor powerhouse expected to generate over $1 billion of revenue in fiscal 2023 and approach approximately $2.8 billion in fiscal 2026. It's a testament to the massive amount of change we are driving across the business in a relatively short time. Now I'd like to turn it over to Neill to go over the quarterly financials, the second-quarter outlook, and provide more details about our updated expectations.

Thanks, Gregg, and good afternoon, everyone. I'll start by providing an overview of the first quarter. We generated revenue of $241.3 million in the first fiscal quarter of 2023, which represents a 6% sequential improvement compared to the $228 million in the fiscal fourth quarter of 2022 and a growth of 54% year-over-year, driven largely by growth in all product lines and the market tailwinds that Gregg referenced earlier. Underpinning the revenue growth is our design-in portfolio, which, along with the additional $3.5 billion this quarter, now sits at $14.5 billion cumulatively. Approximately 43% of our design-ins have converted into design wins, representing more than 1,600 projects. Non-GAAP gross margin in the first quarter was 35.6% compared to 36.5% last quarter and 33.5% in the prior year period, representing a 210 basis point improvement year-over-year. Our gross margin in the quarter was impacted by issues related to our wafer manufacturing process to accommodate longer bull sizes. Related to the Durham fabs, we believe we can continue to improve productivity and performance, but we are reaching our capacity and capability limits, and future significant step-ups in revenue and gross margin will come primarily from the Mohawk Valley fab. However, the Durham wafer fabs will likely remain fully utilized for the foreseeable future as customer demand remains strong. Additionally, as it relates to RF, we were unable to transition from 100-millimeter to 150-millimeter wafer sizes due to the overwhelming demand for our products, which has kept our factories full, leaving us essentially no factory downtime to make the transition. Given the strong demand for our products, we don't anticipate making this transition for at least several years. Thus, RF device products currently represent approximately a 300 basis point drag on our overall company gross margins. It's important to note that although RF products represent approximately 20% of our business today, it will represent only approximately 10% of our business over the long-range plan period. Therefore, we expect this impact to dissipate over time, but it will dampen gross margins in earlier periods of our long-range plan. As a result of these impacts to our gross margins, we generated adjusted earnings per share of negative $0.04 in the fiscal first quarter, compared to negative $0.02 a quarter ago and negative $0.21 in the same period last year. Now before I discuss our guidance, let me provide a quick overview of our balance sheet position. We ended the quarter with approximately $1.2 billion of cash and liquidity on our balance sheet to support our growth plans. DSO was 50 days, while inventory days on hand were 135 days, which is two days lower than Q4. Free cash flow during the quarter was negative $79 million, comprised of negative $13 million of operating cash flow and $66 million of capital expenditures. During the quarter, we incurred start-up costs primarily related to Mohawk Valley totaling approximately $38 million, which is in line with our expectations outlined from last quarter. We expect an additional $34 million of start-up and underutilization costs in the second quarter. We included a non-GAAP adjustment for these start-up costs and a reconciliation table in our earnings release. Now moving on to our fiscal second quarter outlook. We are targeting revenue in the range of $215 million to $235 million. We continue to see increasing demand for our products, both in the short and long term, but our revenue outlook continues to be supply- and capacity-driven. From a supply perspective, we expect our revenue to be impacted by lower yields in our materials business, as previously mentioned, and we are also seeing longer lead times on spare parts reducing tool availability and output in our Durham fab. We believe we are making steady progress on improving the materials yields. Based on current lead times, we expect to see fab output recover by early fiscal Q3. Our Q2 non-GAAP gross margin is expected to be in the range of 33% to 35%. We expect gross margin to be similarly impacted by the material substrate yields previously mentioned, driving performance down approximately 160 basis points quarter-over-quarter. Therefore, we believe our revenue and gross margin growth trajectory to be delayed one to two quarters as we resolve the yield and supply challenges we are currently experiencing. We do, however, expect revenue and gross margin expansion to resume in the back half of the fiscal year and anticipate achieving the $1 billion revenue quarterly run rate early in the back half of the fiscal year. We expect non-GAAP operating expenses of approximately $97 million for the second quarter of fiscal year 2023, and we expect Q2 non-GAAP operating loss to be between $26 million and $15 million. We believe that we will realize approximately $5 million of non-GAAP tax benefits as a result, expecting Q2 non-GAAP net loss to be between $20 million and $10 million or a loss of $0.16 to $0.08 per diluted share. Our non-GAAP EPS target excludes acquired intangibles amortization, non-cash stock-based compensation, project transformation and transaction costs, factory start-up and underutilization costs, and other items outlined in our press release today. As always, our Q2 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. During the quarter, we also announced plans to construct the world's largest materials factory in Siler City, North Carolina, and we are also evaluating further expansion of our device capacity. The construction of this new North Carolina facility will require significant investment from our end. We believe that it's prudent at this time to increase our CapEx guidance from $550 million last quarter to approximately $1 billion for the fiscal year 2023 to reflect the increased investments and support the higher revenue growth we outlined on last quarter's earnings call. We continue to explore multiple avenues to finance these capital investments and are extremely encouraged by the conversations we have had to date. Our shareholders are top of mind in pursuing this funding, so we will explore all options with a goal of minimizing both our cost of capital and dilution. As a reminder, we have many funding paths at our disposal, most of which have little or no dilution impact, including government incentives, customer capacity upfront payments, private or project debt-based financing, as well as going to the public markets as we have done previously. We're currently focused on the less dilutive financing options, and we will continue to remain flexible as we manage through variations in the capital markets. What is clear is that demand for our product continues to be strong, both in the short and long term, and we will continue to invest in capacity to address this multi-decade growth opportunity. With that, I'll pass it back to Gregg.

Thanks, Neill. We are very encouraged by the market trends and with our progress to capture a sizable share of the opportunities in our pipeline. One of the things underpinning our confidence is the breadth of our total design-in portfolio. The electric vehicle has been and will continue to be the driving force behind the broad adoption of silicon carbide. As industry supply scales and costs decline, this is also opening up the door for other applications in the industrial and energy sectors. Just to get a sense of our Q1 design-in profile, approximately 90% was tied to automotive, whereas the remaining 10% was for industrial, energy, and RF applications. The Q1 design-in total is a 9x increase for automotive year-over-year, and industrial, energy, and RF increased more than 95% from a year ago. This quarter’s design-ins include an interesting range of applications, including weather radar, wireless EV bus charging, a welding machine, and a motor drive application. To service this rapid growth in demand for silicon carbide, during the quarter, we announced our Siler City materials factory, which will be the world’s largest silicon carbide factory when it opens in 2024. The substrates produced there will help drive down the cost of devices and expand silicon carbide adoption across even more markets. Our new materials factory, in combination with our plan to build out both the remainder of our Mohawk Valley factory and a yet-to-be-announced second fab will support this goal and should help us achieve significant scale. And speaking of Mohawk Valley, the fab continues to make great strides in its ramp. During the quarter, we successfully ran full flow lots in the fab, and not only have we been able to run these lots, but we are very encouraged by the yields we are seeing at such an early stage. We are still on track to deliver devices from Mohawk Valley in the second half of fiscal 2023 and plan to share an update on our progress at our Investor Day on Monday. The multi-decade opportunity in power devices requires far greater capacity investment as soon as possible. We will continue to address near-term challenges in Durham and RF as we continue to bolster our leadership position in silicon carbide. We will need to raise a significant amount of capital which will go towards investments in the necessary infrastructure to support growth. As a result, free cash flow generation will be pushed out a few years. Margin progression will likely be muted in the near term due to the Durham and RF dynamics mentioned earlier. However, we continue to believe Mohawk Valley will help improve margin trajectory as it comes online. This fiscal year, demand for our products continues to outstrip supply, and our revenue will be gated by the speed at which we can increase output. That being said, we still expect top-line year-over-year growth north of 30%. When I started at Wolfspeed five years ago, a key theme was refocusing the business. I am proud of the progress the team has made in that regard, but there is still more work to be done. There will be challenges driven by the unprecedented demand for silicon carbide, but overall, we are extremely encouraged by the dynamics that underpin these challenges. I look forward to discussing these topics in more detail during our Investor Day on October 31 at the New York Stock Exchange. We’ll provide further updates on our strategic initiatives and long-term financial model. If you have not registered for the Investor Day, please do so by this Friday by contacting our Investor Relations team. And now, I’ll turn it over to the operator for questions.

Thank you. Our first question of the day will come from Harsh Kumar of Piper Sandler. Harsh, your line is now open. Please proceed.

Yes. Hey, thanks, guys. So question on the near-term. Gregg, when I look at your business, all the design-in, design win trends are pointing upward. But I’m looking at the December quarter guidance, which is sequentially down. I know you mentioned a handful of things such as spare parts availability, also the longer bulls. I was curious, is this what is impacting your ability to grow in the December quarter? And then just – or is there something else that’s going on that’s worth noting? And then I had a follow-up.

Thanks for the question, Harsh. Yes, it is exactly that. Basically, it’s taller bulls and some yield issues we have processing them in the back end and the lead time on spare parts of older fab equipment inside the factory. Basically, those two issues are limiting our output. Our near-term demand from customers is up as is our longer-term demand. In fact, our unfulfilled demand is increasing this quarter due to this limitation we have. So that’s exactly what it is. I might mention, though, that taller bulls are a really good thing. And as we’ve done a good job of refining the back end of our process here, as we come out of that and we have yield back to where we believe we can get them to, these taller bulls are going to be substantially beneficial for us.

Got it, Gregg. And then for my follow-up, Gregg, I wanted to ask about the gross margin. A similar sort of question. I was curious if you could sort of split the gross margin difference on the downtick between, hey, is this a bigger problem that’s coming from the longer bulls? Or is this a spare parts issue? And also maybe help us think about some color on when these issues might get resolved, Gregg, if possible.

Hey Harsh, it’s Neill. I’ll take a shot at that. I think if you look at both revenue and gross margin, the issues are really the same; the same two things that we’re seeing. The output related to the power rule has been challenged based on the yield. We’ll see that impact both revenue and gross margin, although I’ll say that I think we hit the bottom there on the yield issue. We’re starting to work our way up. So we’re kind of flushing through some of that higher cost inventory as we start to manage through this. I’d say the same thing in terms of the Durham fab production. We have some tool availability challenges related to spare parts and older equipment. We’ve been impacted by some supply challenges clearly, and that’s something we’ve really avoided largely in the last couple of years. So you did buy that a little bit here. That will drive our device revenue down quarter-over-quarter in the margins as well. But again, once we see these current lead times come in, we’ll start seeing production pick up again in the fab. So I think on both cases, both revenue and margin are being impacted by the same two issues. I see these as being temporary in nature. It’s kind of a one-quarter dip in both revenue and gross margin. We see ourselves returning to stronger revenue and margin growth in Q3 and beyond, possibly even being at that kind of $1 billion annualized revenue run rate by Q3 and really back on trajectory by Q4. So you could think of these manufacturing and supply issues just driving a one or two-quarter impact on the revenue margin trajectory.

Appreciate the color, guys. Thank you.

Thanks, Harsh.

Thank you. And our next question is from the line of Brian Lee of Goldman Sachs. Brian, your line is now open.

Hey guys, good afternoon. Thanks for taking the questions. And then maybe just to follow-up on Harsh’s question. You sort of alluded to it a little bit, I think, Neill, but if we were trying to quantify the impact on the revenue outlook here for December, obviously, Gregg, you’re saying your demand and unmet demand is higher. But how much – if you could quantify, I know it’s a tough question, is coming from yield and how much is coming from the supply challenges? And if I take your comments that you’re going to be at a $0.25 billion run rate by fiscal Q3, does that infer you’re like $25 million off of the level you would have guided to had you not had these two issues? Just trying to unpack what the moving pieces are and how much they’re worth? And then I had a follow-up.

Yes, it’s hard to say exactly, Brian, but I think you’re heading kind of in the right direction, so to speak. I think from a yield perspective on the taller bulls, like I said, we hit bottom there, we’re starting to recover. We’ll actually see substrate revenue start to increase going into this quarter, just not at the trajectory we had previously anticipated. And then from a fab perspective, it’s really a function of getting these tools up and running and the lead times we have on spare parts and getting them running. We have the capacity. We have the tools. We need to run the revenue through them and push it to the back end where we’ve got capacity as well. So it really is both on a revenue and margin perspective, these two issues are kind of slowing us down. I think we’ll come back up to that higher revenue trajectory you referenced as we get to the back half of the year.

Okay. That’s helpful. And then not to focus too much on the short-term, but I think this does call into question some of the cadences we’re all modeling here through the next one year to two. When we think about gross margins, you made a comment, you’re going to see some recovery into fiscal Q3 back to where I think you were trending before the yield issues. So 35%, maybe 36% non-GAAP, that’s where you were before this temporary downtick. Is that where we’re headed back to in the back half or because I think the original trajectory might have called for something in the higher 30s, maybe even reaching close to 40% exiting this fiscal year. But what trajectory are we kind of getting back to if that’s the way we should be thinking about this being a one or two-quarter phenomenon before you get to higher margins in the back half?

Yes. Obviously, we’re going to be lower this quarter, but I do see us starting to expand margins again and get back into Q3. It’s a one to two-quarter impact, Brian. So you kind of think of last quarter, we had some of that impact start. We’re seeing more flushed through here in Q2, you’ll probably see some impact or maybe a less impact in Q3 as we start to expand again and then kind of back on track as it gets kind of a Q4 period.

All right. I’ll take the rest offline. Thank you, guys.

Sure.

Thank you. And our next question is from the line of Jed Dorsheimer of William Blair. Jed, your line is now open.

Hey, thanks for taking my question. Good to be back. So I guess, first question, when you talk about elongating or lengthening the height of the pool, I’m not sure how well understood. But if you are going through a process change and have higher confidence in your recipe and elongate the duration of growth, while near-term, you’re going to see a yield hit that should result in less operating and maintenance because you’re not going to be cleaning out that oven or furnace to be more precise as many times during the year. So I’m just wondering in the near-term, as you see the hit on materials, would you mind unpacking sort of the benefit that you see too as to what’s prompting you to make this move at the materials level? And then I have a follow-up.

Okay, Jed. I’ll take that. We obviously have a continuous process improvement program across all of our different businesses, and this is part of that. We are very excited about the quality of the pools and the height of the pools that we’re now getting out of this process. So that is, we feel very, very good about that. And what we’re really talking about is handling pools in the back end of the flow that are sizably larger than what we historically have. So as Neill said, we’ve made really good improvements in place, and we’ll get back to where we need to be within a couple of quarters here. So I think that’s moving all in the right direction. And the benefit, Jed, is exactly as you alluded, I mean, basically, you’re going to get more wafers for silicon carbide crystal, and that will increase the output and decrease the cost. So these are – as we improve the back end of the flow here, this is going to be a real good thing.

Got it. That’s helpful in what I thought. So I guess, just as my follow-up question, with respect to Mohawk Valley, I was wondering if you would update if you don’t mind, where you’re at. I think the milestone was sort of running customer silicon. And where are you at with Mohawk Valley to maybe help with confidence in terms of getting back to that or getting to that run rate that you talked about?

Yes. So Jed, we’ve had a number of full flow wafer lots go through the fab. All of the full flow wafer fab will last for a month and been through the fab have yielded good electrical diode or good chips, and we’re very pleased with the yield numbers that we’re seeing right now. That’s all looking, I would say, as good as it can get, so it’s really looking pretty good. In fact, we have so much confidence that we’re actually running material right now that is meant to qualify the fab, that is well ahead of any schedule that you might imagine. So we’re really excited about that. Once qualified, customers will need to qualify by the parts that typically most of our conductor companies have grabbed the customers and kind of pulled along with you on that. I think with the supply-demand mismatch, we have many more customers that are volunteering to be first in the fab and they want to have their parts qualified first, etc. So I would anticipate the customer qualification process to be different than normal. We should be shipping revenue out of that fab by the end of this fiscal year.

Great. Thank you. And our next question is from the line of Samik Chatterjee of JPMorgan. Samik, your line is now open. Please proceed.

Thank you. Thanks for taking my questions. I guess, if I could just ask a clarification on the commensurate to Mohawk ramp. The supply issues or the issues on parts, etc., that you’re referencing today. Just wanted to confirm here that is that impacting your ramp on Mohawk as well? Or is that an issue with sort of old parts or old equipment and not really something that carries over to how you’re ramping Mohawk? And relative to the same issue, Neill, you are sort of giving some guidance about when you see gross margin expand again, does that then include your thinking in terms of revenue and gross margin impact from Mohawk in the back half of this the impact as more comes into the non-GAAP number? And then I have a quick follow-up. Thank you.

Thank you. I’ll take the beginning part of that, and Neill can handle the back end of it. The spare parts issue is really related to older fab equipment in our term in our North Carolina where that’s not anything to do with Mohawk Valley. Recall, we began building Mohawk Valley in March of 2020. We started in selling equipment in 2021. We did a lot of preordering of long lead time type equipment, and a lot of this was done before other semiconductor companies decided to start building wafer fab. So we’ve actually done a pretty good job of getting on ahead of the long lead time items in Mohawk Valley. Finally, I would just add that those are obviously brand new machines, modern equipment. We’re not looking for spare parts for those machines, and the availability of those in any case would be likely a lot better than some machine that we’ve had in our factory for 20 years or so. Bottom line is, there's no impact on that at all in Mohawk Valley. And then you can comment on the back end of that margin.

Yes. Just from a margin perspective, actually, I think we’re in good shape from a supply perspective in Mohawk Valley. The yields that we’ve seen off these initial lots seem really positive. It’s something we’re really enthused about. So I think that just gives us more confidence about the ramp. As I said many times, the margin trajectory you kind of get in the back half of this year and then eventually into 2024 and beyond could be largely based on Mohawk Valley, and the initial signs of what’s coming at that are very, very positive. It will still be a little bit of a timing issue. We’ll see what happens in terms of qualifications as Gregg talked about, we’re already starting material to that. But let’s see what the timing looks like there. We’re kind of all systems go, and things are very positive from bringing Mohawk Valley online in the back half of the year from a revenue perspective, and that will certainly help underpin the margin expansion as well.

Got it. And a quick follow-up on the RF issue that you’re highlighting relative to not being able to change over to 150 mm just because of high demand that you’re seeing. I’m just wondering like, was that something that was sort of known for like you had more sort of insight into a few quarters ago and sort of decided that this was the quarter where you were going to switch over? Like what was the exact sort of timing – timeline that it played out? And because I would have assumed if you would switch over, you would have sort of buffered both in terms of margins and revenue in the quarter itself in terms of that changeover time, but maybe I’m missing something there.

I think that’s largely correct. I think that a year ago, we were at our Investor Day because it’s something that was in our plans. As the demand has continued to strengthen and strengthen, our factories became very, very full. From that perspective, we’ve kind of increased demand, that’s really left us no option but to delay that transition from 100-millimeter to 150-millimeter in the RF product because there really hasn’t been any downtime. So the way I would think about it over the last six to eight months, we’ve been looking for opportunities to make the transition, but the demand has gotten to such a point that we haven’t really been able to take the downtime to do that. So what that means from a margin transition standpoint, as I mentioned in the prepared remarks, is at about a 300-basis point drag on margins as you think about getting to that kind of 2023, 2024 timeframe, and we’ll just continue navigating that as we go. This is all, again, really just driven by the demand that we’re seeing.

Great. Thank you. Our next question is from the line of Colin Rusch of Oppenheimer. Colin, your line is now open.

Thank you so much. Can you talk a little bit about the composition of these design-ins? How much of this is coming from medium and heavy-duty and some of the higher-voltage applications that may be out there?

This past quarter, 90% of the design-ins came from automotive, and we’re seeing a tremendous positive adoption of silicon carbide in electric vehicles and a significantly steepening adoption of electric vehicles in the overall automotive market. Both of these factors are driving it up and to the right. I think the car manufacturers are well aware that range is a really big deal for our customers and the rate at which you can refuel, so to speak, or recharge your car, is significant. Both of those drive higher voltages, which makes the impact of using silicon carbide over silicon much more pronounced. I think all of those elements are driving that adoption. Outside of that, we have a whole smattering of different designs across the industrial and RF base applications. We talked a little bit about what those ranges are. Additionally, as Neill has mentioned, north of 40% of our design-ins have converted to a design win. That means customers are beginning to ramp production, and that combined with the amount of design-ins we’ve had is really kind of unprecedented. We’ve done $3.5 billion of design-in this quarter, $2.6 billion last quarter, $1.6 billion, and $1.6 billion two quarters prior. The $9.3 billion of design-ins we have is unprecedented and is driving an enormous increase in our revenue near term and certainly the revenue outlook.

Okay. And then just thinking about the cadence of potential debt financing, is that something – how mature is that process for you guys now from a project level in terms of bringing some of that capital in to support this CapEx that for the balance of the year because it’s a pretty healthy number that you guys are looking at spending?

From a financing perspective, just let me remind you that we’ve been proactive with this; we’ve got $1.2 billion of cash on the balance sheet. In addition to the capital plan we laid out a year ago at Investor Day, we’ve seen our CapEx step down over the last quarters. You saw it was $56 million this quarter and just $55 million in the fourth quarter. I do think as we move forward, we’ll start to see a step up in capital expenditures kind of in line with what we’re talking about. I think about that sort of pick up in the back half of the year. So we have a little time to go work at this. We do still need to go out and secure some funding to support that. Dilution as it relates to that financing is absolutely top of mind. There are four buckets that we’re looking at in terms of executing that financing, most of which are not dilutive. The first is government incentives; we’ve been very close to both the governments in the United States and outside of the U.S. and we will be in a position to benefit significantly from incentives, both in our wafer fab expansion and the investment in materials facility in North Carolina. We’ve also got $300 million of incentives remaining with our partnership with the State of New York. We’re also working closely with customers on upfront payments for capacity. This is obviously not dilutive. We also have private finance or project financing, and last, we could consider going to public markets like we’ve done before. The lower dilution options on that list are where we are currently focused, given that step-up in CapEx in the back half of the year. We want to get something done in advance of some of those bigger investments we’re discussing, and that's our current focus.

Hi. This is Blake Friedman on for Vivek. Thanks for taking my question. Just want to focus on the materials business quickly. I know you’ve mentioned historically about holding 60% market share in that business and not to get ahead of the Analyst Day. But I was just curious how feasible it will be to maintain this level of share as we see new market entrants and also an increasing number of vendors internally sourced capacity moving forward.

Yes, I’ll take that. The silicon carbide market is growing very, very rapidly, and I think the supply is going to be chasing demand probably through the end of this decade. It’s just going to be tough to keep up with it. That obviously attracts people to the market. Most of our silicon carbide materials customers, I don’t know all of them, but most have plans to develop their own substrates and so forth, and I think that’s a smart idea and a good plan, and it’s something I would do if I was in their shoes. I think they’ll probably find it a little bit more challenging than I would expect. But that’s basically how we’re thinking about it, and we’re thinking that they’re going to invest and deliver on what they set out to do. That being said, we’ve had a modest thought process in terms of what we’re going to do from a market share standpoint, basically hold share of that external market. Some of that internal demand would be satisfied by the internal capabilities of these companies.

Helpful. Thank you. And then just as a follow-up as well. I know you mentioned the rapidly growing demand for silicon carbide. But also, I know one of your competitors out there is also seeing about $1 billion in committed silicon carbide revenue in 2023. So just on the feasibility of the silicon carbide market even next year having multiple $1 billion vendors. Just your thoughts on that would be helpful.

I think the demand is clearly outstripping supply. To the extent that we can bring on, collectively, the industry can bring on more supply, it’s going to help things. The silicon semiconductor industry is clearly looking like it’s going to see a cyclical downturn here, but silicon carbide has some secular trends that are just going to overpower that, I think, by far. That’s the transition to EVs and clean energy. I think the demand for the industry will help supply through the end of this decade, including us putting into action the world’s largest silicon carbide factory and installing a significant expansion in Siler City with capacity coming on in 2024. Even with all of those multibillion-dollar investments, I think the supply will be chasing demand through the end of the decade.

Thank you. Our next question is from the line of Gary Mobley of Wells Fargo. Gary, over to you.

Thanks for taking my question. On this issue relating to some challenges on the back end of handling some of these longer bulls, I’m curious to know if this may foreshadow some transition issues as you move to 200-millimeter, and in relation to this issue, is this for the supply of captive or merchant materials?

No, I don’t see it related to that at all. In fact, in some respects, any process improvements that we make on 150, we typically can transfer that to 200 and vice-versa. I think it’s a good thing. Having taller crystals means we’re going to have a lower cost, and it’s just a matter of how you handle it in the back end. As Neill mentioned, we’ve implemented a bunch of improvements, and we’re not on the yield issue we discussed, and we’re heading back up north on that. So I think this is the proverbial good problem to have. We’re super excited about the quality of these crystals and the rate at which we can deliver on this. It’s just a matter of fine-tuning the back end of the process.

And relating to captive versus merchant, the impact?

We have always said there are going to be captive suppliers that are developing their own silicon carbide capability. We assume they’re going to be successful at doing that. So that is part of our plan.

Thank you very much. And our next question is from the line of Edward Snyder of Charter Equity. Edward, your line is open.

Thank you very much. Gregg, you mentioned you’re looking for revenue from Mohawk Valley by the end of this year. First off, is that production? Or are you talking about revenue for sample parts? Because if we go back to a year ago, when we were in this Q2 last year, and we had a very detailed discussion of what Mohawk, it sounds like you’re behind by about six months. Suggesting the things we’ve talked about with you guys was that you’d start internal fab qualification probably mid last year, then customer qualifications in March or June. Then we’d start seeing initial production now and then volume production in the second half or beginning of 2023. If we could just reset the expectations for the ramp of Mohawk Valley and understand what that might look like. And I understand it’s a complicated endeavor, so things shook out. Then if I could, maybe, Neill, you’re saying there’s a 300 bps hit to gross margin due to RF, which is curious to me. Is this – and I apologize if I missed it, but were you raising gross margins overall because of the improvements in wafer diameter in RTP? Or has something occurred to reduce the margins that you’re already producing because it seems like I’m really curious about deviations from what we had?

In terms of Mohawk Valley, we’ve got a bunch of lots have gone through the – all of the offsets. The lots that have gone through are performing very well. We’re pretty excited about where we are at. We have material in the fab that we intend to run through our qualification. There’s going to be a lot of simultaneous activity that happens with customers in terms of doing their qualification. We’ve had a lot of outreach from a number of different customers in terms of, as I mentioned, wanting to be first in line because there’s only so much we can get out of the fab in the near term. We’re anticipating both preproduction samples as well as initial production out of that fab by the end of this fiscal year. That’s the June quarter. We’re expecting to get revenue from that. In terms of the ramp, we would begin ramping, and obviously beyond, we anticipate some increasing ramp.

Yes. So on RF, if you go back in the last year and this year, we’ve been running that business and those products – the RF product on 100-millimeter substrates. Our plan was during fiscal year 2023 to make the transition for a large part of the business to 150-millimeter substrates, which was going to help us with margins, not just more important for 2023. If you look at it today, the Durham fab talk about having a higher cost footprint, and we’re running 100-millimeter wafers on that higher cost footprint. Products in RF are facing that margin challenge right now, and this is going to be a solution to help drive up the margin curve on RF. Given the high level of demand we’re seeing, we’re just not going to be able to make that transition this year. We don’t have that downtime in the past, given the amount of heavy demand we’re seeing. What you want to think about is how we’re moving into 2024. We anticipate seeing benefit from 150-millimeter wafers in RF, we are going to see that. We’ve been gradually pushing this out, but we still have visibility right now to have the capacity to make the transition.

Okay. And then my follow-up, if I could. Is the CapEx increased from $550 million to $1 billion? Is that entirely due to the new materials fab? Or is it part of that the acceleration of Mohawk? And then we’re running through, obviously, a recession. You’ve seen the reports guys, things are turning down pretty quick. Are you seeing any change in your customer behavior with regards to orders or forecasts, especially in industrial?

The only change we’re seeing is up into the right as pulling in and increasing and asking Neill for more earlier in terms of demand.

The CapEx outlook has increased almost entirely related to the new materials facility that we announced. A lot of the expansion for Mohawk Valley tool was already included when we took the CapEx to $550 million. As I said previously, the $550 million did not include either the materials facility or a new wafer fab, and the change here is the new materials facility.

Thank you. Our next question is from the line of Matt Ramsay of Cowen. Matt, your line is now open. Please proceed.

Thank you very much. Good afternoon, guys. Appreciate you taking my question. Gregg, I understand the benefits of going to taller bulls on both 150 and 200 and what that can mean long-term. I guess what I’m struggling with in the near term is that you would’ve thought that the rest of your supply chain would’ve been making the transition in anticipation of those taller bulls at the same time, and that you wouldn’t have made the decision to transition to the taller bulls without the back end being ready for it to impact revenue. So I’m just trying to understand it. Everything seems like it should have transitioned to anticipate those taller bulls sort of in concert with each other. And now it seems like parts of the infrastructure aren’t quite ready to handle it, and it’s causing delays. If you could just kind of walk through the different pieces of handling the taller bulls and which ones might have tripped up or not been ready for that transition as you anticipated, thanks.

Excellent question, Matt. We aren’t going to get into a lot of detail on our crystal growth and materials operation, as a lot of that is proprietary and trade secret. Still, I would say that taller bulls caused some challenges in the back end processing of these crystals. The team jumped all over it, got to the bottom of what the challenges were and what we needed to fix and are already on the recovery plan to get back to where we need to be. We’re pretty satisfied with that. It would’ve been great if we didn’t have this dip. But Silicon Carbide is a tough business, and wrapping is not for the faint of heart. The good news is we have a substantial amount of experienced personnel within the company who have been through various trials and tribulations of Silicon Carbide and can help us handle this.

No. Thanks, Gregg. I appreciate the perspective there. I guess as my follow-up, Neill, I know there are a lot of folks, so maybe this is front running Monday a bit, but there are a lot of folks asking questions, and you adjusted here a couple of times about raising funds versus the increased CapEx and your focus on minimizing dilution. But it’s hard to know exactly what you’re going to get from different governments, both in Europe, the U.S., CHIPS Act, North Carolina, New York, etc. It sounds like you’re going to fund the remainder with equity potentially. What I’d be interested in is any line of sight visibility to customer co-funding or customer investments alongside of you guys, what the magnitudes of that look like, and how many engagements you might have. If we’re trying to get to the remainder that might be funded with equity, that piece might provide insight into the commitments to your programs. It would be helpful if you have any color there. Thanks very much, guys.

I think it’s what I’ve talked about before. The big wild card here is we don’t know exactly what the government incentives are going to look like. But the significant majority of what we’re looking at is lower or non-dilutive in terms of what we’re focusing on. In terms of what we want to do and what we want to target, that’s really where our efforts are focused right now. We’ve got the four buckets we talked about: government incentives, upfront payments from customers, private financing, and lastly, capital markets. I’m thinking of it in that order in terms of how we’re promoting a process. We’ve got a lot of levers to pull. The initial discussions we've had have been very positive, but there is some variability related to the items because not all regulations on government incentives have been finalized. It’s hard to give an exact amount of what we’re going to do. But I can tell you this: We’re focused on the lower or non-dilutive elements of that plan right now, certainly as we think about around the funding in advance of some of these higher step-ups and CapEx to support significant growth pickup we’ve seen, particularly in light of the design-ins and pipeline expansion we’ve seen this quarter.

Great. Thank you. Our next question comes from the line of Ambrish Srivastava of BMO Markets. Ambrish, over to you.

Hi. Thank you. Neill, I’m sure I’m not the only one based on questions I’m getting for our investors. I’m a little bit confused with the commentary you provided in the last earnings call where you were very confident about improvement and execution on the back end, and you specifically said that, hey, look, we expect this to continue. While we all appreciate the challenges in ramping the business drag and from where you were versus where you’re going, it seems like there’s a lot of volatility and what happened within a quarter that you went from calling out improvement continuing to a dip in execution. That was my first question.

Yes, I think from an execution standpoint, Ambrish, I appreciate your concern. We’ve got a big ramp in terms of what we’re talking about. We just raised our long-term revenue to 30% to 40%, and the footprint we’re working off today is not the future footprint we’ve been working off. We have a lot of confidence, and we made a lot of progress in our back end execution last quarter. We still see the benefits from that. What we’ve slightly gotten caught on are two growing pain type issues: one is related to the taller bulls, and as I said, I think this is going to be a nice tailwind for us going forward in terms of this great technology. Secondly, we’ve encountered a supply chain issue we didn’t see coming, primarily because we haven’t really had issues with this over the last several years as we ramped the business. It’s a bit of a dip against a backdrop of significant demand and a lot of revenue growth.

From a terminology standpoint, in the semiconductor industry, you have front ends and back ends. Back ends typically refer to packaging, assembly, tests, etc. What Neill referred to last quarter in the back-end improvement was that kind of factor. Today, we’re talking about taller bulls and a challenge on the back end processing of that. Just to make sure we understand and clarify the discussions.

Got it. No, thanks for the clarification. Gregg, question for you. You’re obviously seeing a demand ramp, and you’re very confident about you raised your guidance for what you expect for fiscal 2026. But if you think about free cash flow, and you said it’ll be pushed out, how are you thinking about all the puts and takes if you’re so confident on the demand and on the ramp of Mohawk and the second fab? What should investors, who care about free cash flow, be thinking about when you start to generate free cash flow? Thank you.

Let me just sit down on Ambrish for a bit. I think we are going to put a crusade to take the free cash flow numbers out. But free cash flow is in advance of building what I think is a manufacturing footprint for a high-growth industry with some of the most discerning customers in the world. We’re going to build state-of-the-art capacity and capability that will underpin us for the long term. So I think about having to invest in the business in advance of that. I’ve talked about a two-to-one CapEx ratio as you think about the investments and these types of facilities we’ve discussed. But as you get beyond that into the long-range plan period and look out, the cash generation capability of the footprint we’re bringing online to match the demand we’re seeing in the business is tremendous. We’ll give you an update on how that all works on Monday.

Great. Good afternoon. Thanks for taking my question. Maybe in the same vein, Gregg, as the previous question or questions, do these kinds of newer issues now that you’re seeing on the Durham fab, does that change your view of the Durham fab long term? Does it change any of the plans you may have for that fab longer term? Is there anything new there? That’s my first question. And just to clarify for Neill, on the three points of gross margin headwind on the RF side, as far as I understand, it doesn’t change the FY 2024 target on the margin side, correct? It’s still in line with what you indicated previously. Thank you.

The team led by Rex Felton has done an excellent job stabilizing and improving the Durham wafer fabs. Currently, we are addressing the spare part issues with older equipment in the fab. While we are making progress, the Durham fab will not reach the same level as Mohawk Valley, as they represent entirely different generations of fabs. One is highly automated and new, while the other is not automated and is 20 to 30 years old. They will never be the same. That said, the Durham fab has shown significant improvements but still has more work to do, and we are currently managing some supply chain issues.

On the RF margin impact and looking out to 2024, I think, like we said earlier, we continue to see strong demand and anticipate significant over the short and long term. It’s just not leaving us enough opportunity on downtime to bring it down and make that transition. It will impact our 2024 margin trajectory. The 300 basis points is the number you want to consider as you think about 2024. We anticipate seeing benefit from 150-millimeter wafers in RF, but we’re currently not in a position to make that transition. We’ll serve our customers instead of making that choice.

Very helpful. Thank you.

Thank you. Well, thank you very much, everybody, for participating in the call. We look forward to seeing you next Monday, October 31 in New York. Thank you.

Thank you to everyone who has joined the call today.