Wolfspeed, Inc. (WOLF) Q2 2023 Earnings Call Transcript

Good afternoon. Thank you for standing by. And welcome to the Wolfspeed Incorporated Second Quarter Fiscal Year 2023 Earnings Call. Currently, all participants are in listen-only mode. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. We ask that you limit yourself to asking one question and one follow-up. Thank you. Please note today’s call is being recorded. I would now like to hand the conference over to our first speaker today, Tyler Gronbach, Vice President of Investor Relations. Please go ahead.

Thank you, and good afternoon, everyone. Welcome to Wolfspeed’s second quarter fiscal 2023 conference call. Today Wolfspeed’s CEO, Gregg Lowe; and Wolfspeed’s CFO, Neill Reynolds, will report on the results for the second 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 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 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. Before we get into the results of the quarter, I’d like to take a moment to remember our late founder and CTO, John Palmour. We had a celebration of life last weekend, during which we announced that we would dedicate our Siler City manufacturing facility in his memory, naming it The John Palmour Manufacturing Center for silicon carbide. All of us knew John, through his nickname JP, and so the nickname for our facility will be The JP. He worked for over 35 years to advance and promote silicon carbide and largely as a result of his efforts, the world is recognizing its potential. We believe that silicon carbide is on the cusp of mass adoption and that our long-term outlook remains on track. First, electric vehicles were the bright spot in the auto market in 2022, despite many headlines that auto sales have slowed. Global EV sales grew more than 65% year-over-year and represented 10% of all vehicles sold in the calendar year. We have seen this overwhelming demand play out at Wolfspeed, as our recent partnerships with industry leaders such as Jaguar Land Rover and Mercedes-Benz point to the strength in the demand for EVs and our ability to take share in this space. We remain confident in the industry’s strong long-term fundamentals and believe Wolfspeed is best positioned to capitalize on the rapidly growing demand. Second, our $1.5 billion of design-ins in the quarter point to continued robust demand for our power devices. To date, 46% of our design-ins have converted to design-ins, representing more than 1,800 projects. We are coming off multiple quarters of record design-ins with a total of more than $16 billion of design-ins over the last three years. Now of course, there will be some variability in our design-in numbers from quarter to quarter based on timing of new agreements and decisions by customers. We anticipate that as our manufacturing capacities expand with new facilities, we will continue winning in the device marketplace. Third, we continue our market leadership position in the materials business, the aspect of our business with the highest barriers to entry. We recently announced an expanded agreement with another leading supplier of silicon carbide materials, which illustrates the intense demand for silicon carbide. From where we sit, the industry remains supply constrained and this will continue to be the case for the foreseeable future. It is clear to us that the opportunity in silicon carbide technology is generational given the pace of adoption we have experienced over the last few quarters. At our Investor Day, I remarked that I have not seen growth like this in my 30 years in semiconductors, and that view has not changed. While customer interest remains strong across both materials and power devices, as we discussed previously, silicon carbide production and manufacturing can present challenges along the way. Our Durham crystal growth operation, which is the world’s largest silicon carbide materials factory, currently supplies our entire device business and a significant share of the merchant market. However, that is still not enough to support the massive accelerating demand for silicon carbide. With the intense growth in demand for both captive and merchant wafers comes the challenges of growing our materials output as well. We have continued to refine our crystal growth operations and had a recent breakthrough in our ability to grow taller bulls. The initial challenges in managing these taller bulls in our back-end processing have been resolved, resulting in significantly higher yields. It will take a few months before we return to normal production schedules for these materials as the improved product makes its way through the work-in-progress, but we are encouraged by the results that we have been able to achieve with these taller bulls. Long-term, The John Palmour Manufacturing Center for Silicon Carbide is critical to addressing the supply-demand disconnect that will support our expanding device footprint at both Mohawk Valley and a soon-to-be announced fab, as well as the ever-growing demand for merchant wafers. Construction of The JP is progressing well since groundbreaking in September and things remain on track as we updated during our last Investor Day. Regarding the progress at Mohawk Valley, we previously said that we anticipate revenue flowing through the fab in the second half of fiscal 2023. We remain on a trajectory to meet that target, and that will largely depend on our ability to complete qualifications and ramp the supply of 200-millimeter wafers, which we believe we will achieve. We continue to successfully run test lots through Mohawk Valley, which gives us confidence that we are ready to begin scaling production and recognizing revenue from Mohawk Valley in the fourth quarter of this fiscal year. As a reminder, Mohawk Valley is a first-of-its-kind fab, purpose-built to produce next-generation silicon carbide power devices. We are in the final stages prior to scaling production in Mohawk Valley and one of my top priorities over the next few quarters is to ensure that we execute on that plan. We have a strong team and clear strategy in place and are confident in our ability to deliver strong results for our shareholders. While there may be some variability in our short-term results as we qualify and scale the world’s first 200-millimeter silicon carbide device fab, while also scaling the first production of 200-millimeter silicon carbide wafers, we are well positioned to capitalize on the explosive growth that we see through the end of this decade. Now, I’d like to turn the call over to Neill to discuss our quarterly results. Neill?

Thank you, Gregg, and good afternoon, everyone. During the fiscal second quarter of 2023, we generated revenue of $216 million at the low end of our guidance range, which represents a 10% sequential decline when compared to the $241.3 million in the fiscal first quarter of 2023 and growth of approximately 25% year-over-year. As Gregg mentioned, we continue to see strong demand for our silicon carbide solutions. However, the supply chain issues we discussed last quarter caused variability in our quarterly revenue in the second quarter with equipment spare part shortages limiting our Durham fab output, while at the same time, we continue to work through the ramp of our taller 150-millimeter bulls. I am pleased to report that we have made significant progress on both issues and they are currently processing these improvements through our production cycle. In terms of our power devices, which grew approximately 48% in the quarter versus last year, we saw strong performance ahead of our expectations, mostly resolving the Durham spare parts supply chain issue we discussed last quarter. From a power device supply perspective, we now believe that we have achieved full capacity in our Durham wafer fab and virtually all future topline growth for power devices will come directly from the Mohawk Valley fab. From a materials perspective, we made very significant progress in improving yields on our taller 150-millimeter bulls. These yields are now comparable to our historical yields on shorter bulls. However, back-end wafer processing cycle times recovered later in the quarter than anticipated, resulting in lower than expected Q2 revenues for our materials products. We believe this past quarter represents the bottom of the revenue trough related to this issue as we exited the quarter at yields, cycle times, and shipping rates that will all support future materials revenue growth. During the quarter, we also saw weaker demand for RF products due to secular headwinds with recession-related pullback in 5G demand. This resulted in lower than expected revenue for RF devices, which we expect to remain weaker in the second half of this fiscal year. Non-GAAP gross margin in the second quarter was 33.6%, compared to 35.6% last quarter and 35.4% in the prior year period, representing a 180-basis-point decline year-over-year. Gross margin was negatively impacted by the previously mentioned lower yields on the taller 150-millimeter bulls and lower output of the Durham fab due to the supply chain challenges. While we made significant progress on both issues in the quarter and expect to see improvement moving forward, they both represented a drag on gross margin during the second quarter. In addition, RF devices continue to be dilutive to our consolidated gross margin. As we discussed, because of the immense demand for our power devices, we have not been able to optimize the RF manufacturing footprint as we had previously planned. We expect our RF product line to negatively impact our consolidated gross margin by approximately 200 basis points for the next few years. As a result of these items, we generated adjusted earnings per share of negative $0.11 in the fiscal second quarter, compared to negative $0.04 a quarter ago and negative $0.16 in the same period last year. Notably, adjusted EPS this quarter was favorably impacted by approximately $0.05 of non-repeatable events in other income and tax. Excluding these non-repeatable items from our earnings, we would have been at an approximately $0.16 loss per share during the quarter. Before I discuss our guidance, I will provide a quick overview of our balance sheet position. We ended the quarter with approximately $2.5 billion of cash and liquidity on our balance sheet to support our growth plans. DSO was 62 days, while inventory days on hand was 161 days, which is 26 days higher than Q1. Free cash flow during the quarter was negative $171 million, comprised of negative $67 million of operating cash flow and $104 million of net capital expenditures. During the quarter, we incurred startup costs primarily related to the Mohawk Valley fab ramp, totaling approximately $38 million. Moving forward, we expect overall startup and underutilization charges for Mohawk Valley to wind down as we ramp the fab included a non-GAAP adjustment for these startup costs in the reconciliation table in our earnings release. In terms of our capital needs, since we last spoke, we have made great progress in securing funding for our greenfield facility construction and long-term capacity expansion plans. In November, we announced a successful convertible note offering anchored by one of our largest strategic partners BorgWarner. We were extremely encouraged by the demand we see in the marketplace and believe it sets us up well to secure further funding. Additionally, we are still evaluating other avenues of additional funding, including government funding in the United States and Europe, as well as upfront customer payments or investments, capital markets, and debt. As we stated previously, cost of capital and potential dilution is top of mind for us when we are pursuing additional capital. Now moving on to our fiscal third quarter outlook. We are targeting revenue in the range of $210 million to $230 million. Our revenue guidance reflects continued strong demand, as well as supply execution improvement in both our power device and materials product lines, partially offset by continued softness in RF demand. Our Q3 non-GAAP gross margin is expected to be in the range of 32% to 34% as we expect to see some improvement in both power device and materials products, offset by RF weakness due to the lower volumes. We expect non-GAAP operating expenses of approximately $98 million to $100 million for the third quarter of fiscal 2023. We expect Q3 non-GAAP operating loss to be between $22 million and $30 million, and the non-operating net loss to be approximately $3 million. We believe that we will realize approximately $5 million to $7 million of non-GAAP tax benefits as a result and expect Q3 non-GAAP net loss to be between $15 million and $20 million or a loss of $0.12 per diluted share to $0.16 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 as outlined in our press release today. As always, our Q3 targets are based on several factors that could vary greatly, including supply chain dynamics, overall demand, product mix, factory productivity, and the competitive environment. With that, let me pass it back to Gregg for his closing remarks.

Thanks, Neill. Despite some macroeconomic pressures on the silicon semiconductor market, we are confident in our long-term outlook and the strong secular trend for the demand for silicon carbide. Our design-in number continues to be robust and the opportunity pipeline remains at a staggering $40 billion. We have a strong pipeline of design-ins across a wide range of applications, including automotive, industrial, and energy. We are increasingly well positioned to capture a significant share of this opportunity and are committed to investing in the necessary infrastructure to support our growth. As far as our infrastructure goes, our focus on ramping Mohawk Valley will allow us to better scale our power device production, while our 200-millimeter materials capacity also scales. The learnings from Mohawk Valley have given us a blueprint on how we will approach the construction and ramp of our next fab. We should have an update for you on those plans very soon. The immense demand for both merchant and captive materials gives us further confidence in our decision to expand the Durham materials footprint and build The JP, dramatically expanding our materials capacity. This factory will be a game changer for our business and will allow us to increase supply at unprecedented levels compared to what is currently in the marketplace. We were encouraged by our convertible note offering in November, and we are focused on effectively deploying this capital to further our capacity expansion plans and generate returns for our shareholders. Now there will be challenges as we ramp our new facilities, but we will attack them quickly and use our 35 years of experience to resolve them and keep progressing forward. And now, I’d like to turn it over to the Operator for questions.

Our first question is from Harsh Kumar with Piper Sandler. Your line is now open.

Thank you for the opportunity to ask a question. Gregg, I wanted to inquire about the revenue levels for the December quarter compared to our expectations. You mentioned some bull-related issues and equipment challenges with your older fab in Durham, in addition to back-end issues in the materials business. Could you help us understand the contribution of each of these factors to the revenue? I'm not looking for exact figures, just if one had a significantly larger impact than the others. Also, I've noticed that the guidance moving forward has a much smaller cadence than usual, with the midpoint only increasing by $4 million to $5 million. Is this due to a conservative approach, or are you looking to get a clearer understanding of the issues before you provide guidance for larger increases? I have a follow-up question as well.

Hey, Harsh. This is Neill. Let me take a moment to address this. There are many factors at play here. Let me break that down a bit and also reflect on our direction moving forward based on your comments. Firstly, I want to emphasize that we continue to see robust demand for both power devices and materials. As we discussed earlier, the challenge lies more with supply rather than demand, so our primary focus is on increasing supply. However, we did notice a decline in the RF market this quarter, with some orders delayed. Comparing Q1 to this quarter, there's been approximately a 25% decrease in outlook. Looking into Q3 and Q4, we expect about a $15 million drop in revenue from our previous expectations, primarily due to weaker demand in RF. Additionally, we encountered two issues last quarter. One was related to lower yield from the 150-millimeter bulls, which has now been resolved. It took longer to achieve optimal cycle times and throughput, leading to a slight delay in shipping and increased inventory. On the positive side, we are overcoming this issue and moving forward. The second issue involved the Durham fab, which faced some supply chain challenges but has turned out better than we expected. Currently, the Durham fab is at capacity, and we estimated an annual revenue of $400 million from it for power devices, translating to around $100 million each quarter. We will remain capped at this level until we ramp up Mohawk Valley, which will be key for future revenue growth in power devices.

And Harsh, I would just add that we are currently at a pivotal moment as we process materials at Mohawk Valley. We are preparing for revenue from that factory in the fourth quarter of this fiscal year as we qualify the product. The yields from our preproduction runs are giving us strong confidence in our ability to achieve that, and in fact, they are higher than we expected at this stage. We are very pleased about that. As we increase the operations at this facility, which was just a field of mud three years ago, we expect a significant boost in capacity, which will help us meet the considerable demand that exists.

Hey. Very helpful guys. And for my follow-up, actually, it’s a good segue into the Mohawk Valley schedule, so very pleased to hear fourth quarter, which is June quarter of revenue ramp. I have been already getting some questions from investors on how we should think about the revenue scaling to happen there. You have got a lot of pent-up demand, Gregg, and I think the industry relies on basically two or three guys for much of the production of the vertical production, two guys actually, you are one of them. And so help us think about, if possible, how the scaling will happen for that fab as the rest of the calendar year goes on?

Well, I will kick it off and then Neill can talk a little bit more detail. So we are anticipating revenue from that fab, kind of think of it in the single-digit millions of dollars in that June quarter, and then we would be ramping up beyond that. We are ramping up the supply of the 200-millimeter wafers for that at the same time. There’s probably going to be some puts and takes, and we will also ramp it up, and I would describe it as a methodical process. So it’s not just sort of turn on everything at once. But we are very, very pleased with what’s happening with the yields, as I mentioned, both the device yield and the process yields are looking really, really good right now. We expected that to eventually be the case. It’s actually happening earlier than we anticipated.

Yeah. And just to kind of frame up the revenue, as Gregg said, we thought we would probably have around single-digit kind of millions of revenue, maybe even in Q3 and more substantial growth in Q4, we start to ramp up the fab. We will see that push out about a quarter at this point. But it’s going to be a lot of moving pieces. Look, we are bringing up the first, as Gregg mentioned, the first 200-millimeter substrates, we are bringing up the Mohawk Valley fab for the first time. We are in the middle of qualification lots. We are matching that up with customer schedules in terms of qualification. So a lot of moving pieces. So that will probably create some variability here as we move forward. But from where we sit today, we really are on the cusp of bringing this project we have been working on for multiple years and bringing it to reality.

Wonderful, guys. Thank you for the color.

Thanks, Harsh.

Our next question comes from Brian Lee with Goldman Sachs. Your line is now open.

Hey, guys. Good afternoon. Thanks for taking the questions. Maybe just a follow-up on Harsh’s question, because there’s been a lot of intense focus around the exact timing of Mohawk Valley ramp. Neill, you said there’s a bit of a push out here, as you alluded to, I think, people are expecting some minimal revenue in the March quarter and then ramping through the back half of fiscal 2023. Now it’s June. So it’s a quarter behind. Is this a bull back-end processing issue, is it customer calls taking longer? I guess just a sense of maybe pinpointing what the issues are. I know there’s moving pieces, but it almost sounds like as you are navigating this. Maybe frame for us kind of how you feel about the June quarter, these issues not repeating and maybe having even further push outs? And then I have a follow-up.

Thank you, Brian. We are approaching this ramp cautiously. We are establishing the world's first 200-millimeter silicon carbide wafer fabrication, which involves a lot of variability. We are very satisfied with the current output of the fab, but we want to ensure we don't falter after putting in three years of hard work. Therefore, we will increase production in a systematic manner. We currently have materials processing in the factory, and it's looking promising. We expect to qualify it and generate our first few million dollars in revenue by the June quarter. We have customers ready for that, and we will continue to ramp up in the subsequent quarters. Overall, we are quite confident that we can achieve this. There will be some challenges to address as we still need to qualify, but based on the data we have today, we feel optimistic.

Okay. Fair enough. And then a follow-up for you, Gregg. I think you mentioned the design-ins, I call it, a 46% kind of conversion number. I think you were talking about in terms of projects. So I am taking that to assume its units. Is there somewhat of a kind of similar conversion metric you can provide in terms of design-ins to revenue, just whether that’s in the quarter or something you have seen cumulatively and if that’s sort of the right framework to think about success on the design-in pipeline going forward? Thank you, guys.

Sure, Brian. So when we talk about that 46% number, that’s the 46% of the design-ins that we have, have transitioned from design-in to design win, which means we are starting to ship initial production volume. So it’s a percentage of the projects, it’s not a percentage of the total dollars, it’s a percentage of the project. So think of it as 46% of the projects that we have won, where customers have given us a design-in have now transitioned into that initial phase of production ramp, which is really remains an astounding percentage to me. It’s a lot faster than I would have anticipated. Most of those are going to be more industrial-type projects, because they typically have a shorter ramp profile compared to automotive, but we are seeing good traction on the automotive ones as well. So that’s how to think about that.

Okay. But presumably unless the project values, the project scope were to change, the projects converting at 46% or so would also translate pretty similarly on a dollar basis?

Yeah. And what we do from a forecasting perspective is, we start with, obviously, our overall opportunity pipeline and then we have design-ins. And when we look at going from design-ins to revenue, we put a pretty conservative filter on that, assuming some projects aren’t going to make it all the way through, some customers are going to not go into production with the project, a lot of things can happen in between now and then. So we have put a pretty conservative factor on there in terms of kind of framing the revenue compared to what the design-ins are and that 46% number gives us a lot of confidence in the amount of conservatism we have had on that.

Okay. Thanks a lot, guys. I will pass it on.

Thanks, Brian.

Our next question comes from Samik Chatterjee with JPMorgan. Your line is now open.

Hi. Thanks for taking my question. I guess for the first one in near-term and then maybe a longer-term question on the second one. I know last quarter, there was the guidance about sort of exiting fiscal 2Q or the December quarter at roughly $1 billion run rate of revenue and based on sort of your commentary today, it seems more you are saying the scaling to that $1 billion sort of revenue run rate even when we think about fiscal 4Q, if you sort of put Mohawk aside, is maybe a bit difficult because RF demand has moderated and essentially your turnover is a bit more gap in terms of power devices. Am I getting that right, in terms of even moving sequentially from higher from March to June, it sounds like you are saying it’s a bit more limited in terms of getting to that $1 billion run rate or is that unchanged? And then I have a follow-up.

Yes, that’s mostly accurate. Let me clarify to ensure we’re all aligned. Back in October, when we analyzed this quarter along with the challenges in tolerable yields, supply chain issues, and the Durham fab, we expected to hit close to a $1 billion run rate or around $0.25 billion in revenue during Q3. You can consider that as being in the range of 2.25 to 2.50 during Q3. However, RF has been a setback, with demand at about $15 million per quarter, and we expected some revenue from Mohawk Valley, which has been delayed. As we look ahead at revenue timing with Durham, we see RF numbers remaining low. We do expect some improvement from better yields and shipping rates for materials. The crucial factor will be when and how we ramp up Mohawk Valley. Consequently, our revenue and margins will largely rely on the timing of Mohawk Valley. This means we will face limitations in generating revenue in the latter half of this year, outside of RF, until we can increase supply from Mohawk Valley, which seems to be a key focus going forward.

Okay. Got it. And for my follow-up, I saw in your press release, you announced the partnership that you have with ZF and their press reports out there indicating you have an agreement in terms of a new plant in Germany. Sort of maybe sort of a two part, one, sort of it seems like what you are indicating is you haven’t really confirmed or made a decision yet on the new fab in Germany, and secondly, sort of tilting more towards Tier 1 suppliers like ZF and BorgWarner with some of your capacity announcements. Is that a change versus how you want to go to market with more sort of direct approach to the OEMs in the past? Just curious sort of given that more recently you have been announcing engagement with the Tier 1s? Thank you.

Yeah. Thanks for the question. And recently, in fact, in early January, we made an announcement together with Mercedes. So we have had a consistent sort of theme of both Tier 1s and the OEMs in terms of announcements. OEMs that have been announced have been General Motors, Jaguar Land Rover, Mercedes. Tier 1s, of course, ZF, BorgWarner, a number of others as well. So there’s no change in that. I think we have been pretty consistent that we have been winning long-term agreements with both the OEMs and the Tier 1s, and as this transition from internal combustion engine to EV has such a dramatic change for the automotive makers, I think you are going to see a lot of engagement in both of those. In terms of our next fab, we mentioned at our Investor Day that the demand for our products is so strong that we need to have a new fab in place kind of ramping up in the 2027 timeframe. If you subtract then from that the amount of time it would take us to build and ramp that factory. It says that we need to be starting to put that thing in place in 2023. And so what I would say is, just kind of stay tuned for that. We have got a lot of work going on there and as we make announcements on that, we will be able to comment on it.

Thank you. Thanks for taking my questions.

Yeah.

Our next question is from Gary Mobley with Wells Fargo. Your line is now open.

Hey, guys. Thanks for taking my question. I had a follow-up on the potential for the new silicon carbide wafer processing facility since you brought it up in your prepared remarks, Gregg, I will probe a little bit deeper. The potential for that with a joint venture, would that mean the joint venture partner would take the bulk of the output of that facility, if not all of it, not too dissimilar from BorgWarner and Mohawk Valley? And how would such a build impact fiscal year 2024 CapEx relative to prior communication?

Yeah. So, what I would say is, we really can’t get into a lot of details on that. I would say just kind of stay tuned on that and then we can be very, very clear.

And I will add there, Gary, just from a CapEx perspective, when we laid out the plan again in October as it relates to CapEx, I mean, as I have mentioned before, that really includes everything. We knew at that point we would need a second fab and a materials facility. And what we have laid out from a capital planning perspective includes all of those things and right now we don’t see that any differently.

Got it. Got it. And for my follow-up, when you announced Siler City, I believe the communication was that all that 200-millimeter output would be consumed internally. Has that view changed at all, or will you be supporting some of these merchant LTSA wafer supply agreements with some of that output? And then maybe if you can just give us a sense of the trajectory of your wafer-related shipments based on some of these new LTSAs?

Yeah. So basically we are at the early phase of really ramping up 200 millimeter and we are doing all we can to ramp it up and feed the Mohawk Valley fab. And we are also doing all we can to drive the cost and the commercialization of that product to a point where we can decide at that point what makes sense from a long-term agreement perspective. At this point, it’s looking like the vast majority of what we will do at The JP now will be 200 millimeter. We do have the ability if we wanted to, to run 150 there and so if there was continued need and demand for 150 millimeter, we could do that at The JP facility. But, yeah, the vast majority of what we are going to be doing in The JP is going to be the 200-millimeter.

Our next question comes from Colin Rusch with Oppenheimer. Your line is now open.

Thanks so much. Folks are getting a little bit more mature in the auto industry around their platforms. Can you talk a little bit about the cycle times that you are seeing in terms of some of the design-ins as they look at scaling some of these platforms into multiple vehicles and moving into multiple geographies?

I would say we are seeing a couple of different things. First off, the cycle from when a customer begins thinking about implementing a new platform to when it goes into production is still in that kind of that four-year to five-year range, I would say. Some of the more startup-type companies can be a little bit faster, but that’s kind of the range. What I would say is happening, though, is customers are taking the platform that they are going to use for vehicle X and they are reusing it for vehicle Y. And so obviously, the cycle time for that is dramatically shorter to be able to just kind of rinse and repeat and reapply the same platform for another vehicle. And we have seen that numerous times across just about, I don’t know, about all of our design wins, but many of our design wins, we have seen where we were in one platform and now we are in two and now it’s four, and I think that kind of is driving some of the steeper ramp that we are seeing in the demand for the product.

All right. That’s super helpful. And then in terms of some of the industrial applications, are you seeing anything new on the horizon that are real accelerants in terms of demand for you guys? Are there areas outside of automotive that are real highlights that we could think about as demand overs for fiscal 2024 and 2025?

We are observing a variety of applications, most of which are small individually but significant when considered together. Any technology that involves energy conversion at high power and high voltage is increasingly shifting towards silicon carbide. This trend is evident in solar and wind energy systems, as well as green energy server farms. Additionally, we are seeing design integrations beyond vehicles, including transportation applications like vertical takeoff and landing equipment and personal watercraft. Customers are actively incorporating silicon carbide into these products. Overall, we are witnessing a broad range of industrial applications, with our exposure largely facilitated by Arrow. They have done an excellent job of providing us access to their vast network, enabling us to connect with customers across various geographies and market sizes to promote silicon carbide.

Our next question comes from Jed Dorsheimer with William Blair. Your line is now open.

Thank you for taking my questions. Gregg, I'd like to ask you about your experiences with the 200-millimeter process over the past three years. Can you share any lessons regarding what has gone well and what hasn't, particularly as we approach the announcement of the second fab? I'm also interested in how the timeline for this second fab compares to the first. I have a follow-up question after that.

I would like to mention a few things. First, we built this fabrication facility during a crisis, which was unexpected. Despite that, three years later, we are starting production, which is quite impressive given what the team has achieved. They followed a solid plan but more importantly, they adapted well when faced with unexpected challenges. You all remember the various obstacles we encountered. Secondly, I want to emphasize the decision to go fully with 200-millimeter and to automate the process was a wise choice. At first, we considered starting with 150-millimeter and later converting to 200, but that would have caused unnecessary distractions. We needed to reach a level of confidence in 200-millimeter, and we achieved that about two years ago. Thankfully, we did, because converting a 150-millimeter fab to 200-millimeter would have been quite difficult. The automation has also delivered exceptional results. I spoke with the team about our yield expectations, and the fact that there are no humans handling these wafers, which can be quite challenging, has had a positive impact. These are some of the positive aspects. While we’ve faced various challenges, the team’s experience has helped us overcome them swiftly.

Got it. That’s helpful. As we consider the ramp, it sounds like your strategy includes building a high buffer inventory and ramping up more significantly, while maintaining a methodical approach to the ramp-up process. I'm curious if you could explain how you plan to manage fixed costs and depreciation on a unit basis when ramping on lower volumes, as this might create near-term headwinds for margins. How should we view the interaction of these factors? Specifically, at 200 millimeters, you will have a lower cost basis. What level of utilization do you anticipate will shift from being a potential headwind to a tailwind for acceleration? Thank you.

Yeah. I will kick it off and then kick it over. I will start it and then kick it over to Neill. We are definitely taking a more methodical approach. And as I mentioned before, we are in really good shape right now, we have got yields that are looking really nice right now and the last thing we want to do is just turn the accelerator too hard and kind of mess it up at the end here. So I think we are in the mode of let’s do this in a methodical way, let’s take it step-by-step. We are really pleased, I said, with the yields that we are seeing out of this, we will be qualifying the product in the fourth quarter and shipping to customers and then we will turn on the fab kind of step by step.

From an overall cost perspective and fixed cost absorption, I believe that’s what your question relates to regarding the new factory. Although I don't have the exact figure, as we mentioned during the Investor Day, Mohawk Valley is expected to break even, at least from a cash perspective, around a 30% to 40% utilization level, which is still applicable. Currently, everything we observe from wafer cost yields to the overall cost structure of the fab looks promising. Moving forward, as I have mentioned previously, we will manage the early stage ramp by accounting for current start-up costs, which we update every quarter. Additionally, we are considering an underutilization adjustment to aim for about 70% utilization of the fab, gradually decreasing that as we build inventory. Right now, what you see is the peak start-up and underutilization figures, which will decline over time, providing a clearer view of the fab's cost capabilities, even with lower utilization. When we mention that the fab will have die costs 50% lower than our current costs in Durham, it is indeed based on these lower utilization figures. We are confident in managing this and will provide updates each quarter. Overall, from a cost perspective, I am optimistic about the margins we will achieve as we ramp up the fab.

Our next question comes from Vivek Arya with Bank of America. Your line is now open.

Hi. This is Blake Friedman on for Vivek. So just touching on the 5G weakness that was mentioned earlier. Just curious if it’s related to any specific geography and with weakness to continue in the second half, is there any way you can quantify how much you expect second half RF sales to be coming in relative to the first half?

From an RF perspective, we are experiencing a lot of variability across our customer base. It likely varies depending on the specific customers each supplier is working with. I see some flattening or even decline in the market across various sectors within the industry. Previously, I noted that we anticipate a $15 million reduction in revenue per quarter compared to our earlier expectations, and I believe this trend will persist as we move through the latter half of the year.

Got it. And then just kind of quickly to just touching on the CHIPS Act and your CapEx cadence moving forward. Is there any benefits there specifically that you can size or just even high-level comments would be useful? Thanks.

On the CHIPS Act, we are very pleased with the progress that has been made. We are awaiting the final regulations, but we believe that the investment tax credit associated with the Act has been very positive. We have already begun incorporating some of those benefits into our financial forecasts, consistent with what we anticipated when we outlined our plan last October. There are no significant changes on that front, and we will continue to collaborate with the government regarding the regulations related to applying for additional funding.

Our next question comes from Matt Ramsay with Cowen. Your line is now open.

Thank you very much. Good afternoon, guys. For my first question, I wanted to ask a bit on the RF business. There was going to be this 100-millimeter, 150-millimeter transition and you guys talked about on the last call and then at the Analyst Day, the margin headwinds that were going to come from maybe not making that transition and that was pretty clear. But as I understood it, the reason for not making that transition was things were so tight in that facilities that you couldn’t sort of shut things down to make the transition and if now we are seeing cyclical demand weakness in RF devices. Is there an opportunity to make that transition now and maybe you can just help me square that circle a bit? Thanks.

Yes. Keep in mind that the facility also produces our power products, so even though there is slightly softer demand for RF, there is still not a viable opportunity to make that transition.

Got it. Okay. So it’s a shared facility then, Gregg, that you are leaning into any flex for the silicon carbide device side rather than making any transition, is that kind of the way to read it?

That's correct. Changing an RF line in a shared facility causes significant disruption, and we cannot afford to do that for our power device customers.

Understood. That clarifies things. As a follow-up, I wanted to discuss the timing of ramping Mohawk Valley and the factors influencing that process. I specifically want to focus on the 200-mil materials aspect and understand what steps are necessary to effectively scale that operation to support Mohawk. What are your priorities regarding materials for the 200-mil, Gregg? Are those priorities still focused on Mohawk Valley devices, and what variables are impacting the ramp-up?

It’s definitely both. We are actively working on the fab, and as I've mentioned, it’s progressing well. Despite a one-quarter delay in revenue, we feel very positive about the developments. We are currently expanding capacity at our Durham campus and are activating additional capability this week to supply more product to Mohawk Valley. This expansion involved converting a basketball court and other facilities into a 200-millimeter silicon carbide crystal growth operation in what we refer to as Building 10. The significant increase in capacity will come from the construction of The John Palmour manufacturing center for silicon carbide, known as The JP. We expect this expansion to boost our capacity by over tenfold. We are thrilled we decided to initiate this project back in September. Just to give some context, we announced the decision on a Friday at The Governor’s Mansion in North Carolina, and we had earthmoving equipment on-site the very next Monday. We recognized the need to move quickly from decision-making to action.

Our next question comes from Katya Evstratyeva with Canaccord Genuity. Your line is now open.

Hi. Thank you. I am filling in for George. Gregg and Tyler and Neill, maybe if you could stick to the demand that is coming from all your design wins and if you are to contrast and compare what’s happening in Europe versus what’s happening in the U.S.? Where do you see most demand coming from, especially given the tailwinds of your recent announcement with Mercedes? Thank you.

I don’t have the exact numbers in front of me, but I can say we are performing very well in both the U.S. and Europe. We have made announcements with GM and BorgWarner, which are North American-based companies. We have also discussed relationships with Jaguar Land Rover and Mercedes, as well as ZF, a European-based company. Some of these Tier 1 companies operate globally, so we are also gaining traction in Asian markets. While I don’t have the precise breakdown, I would say we are succeeding nicely on a global scale.

Thank you, Gregg. Could you evaluate how much of the $1.5 billion in design-in has come from the U.S. compared to Europe in terms of automotive wins?

I don’t have that breakout right now. But what I would say is, if it follows the pattern that we have seen over the last couple of quarters, it’s going to be pretty heavily automotive related, kind of think of it as 70%, 75% automotive related and then 25% would be either industrial type applications, RF applications, and so forth. I am sorry, I don’t have the regional breakout right handy.

Thank you.

Our next question is with Edward Snyder with Charter Equity Research. Your line is now open.

Thanks a lot, guys. First of all, I think, it’s fantastic, you name the facility after John. I think it’s really, really great, guys. A couple of things. First of all, Neill, housekeeping, can we give us a general breakdown of materials versus devices on this in terms of the revenue or you were not 50-50 yet, but can I get a general idea of where that is?

Well, like I said, let me just point out a couple of things, Ed. So the Durham facility is now capped. I said about $400 million a year and that only provides power devices in that number. So about $100 million a quarter were kind of capped on power device revenue until we start seeing more revenue out of Mohawk Valley. Then from an RF device perspective, we are down about 25% from our peak, which back in Q1. So that represents about $15 million a quarter. So I think that should give you the pieces there.

Yeah. Okay. And so given that it’s capped, given that your RF is all the way down, can you move some of the capacity, I imagine you can’t. The RF line can’t be converted and RTP cannot be converted to device, so you can’t stop up the extra capacity, maybe freeing up an RF with devices and expand your RTP. You said Durham has capped at $100 million, but that didn’t include RTP, right, so you have got some revenue coming out of RTP for devices, too, right?

Yes, we do have some power products processing at the RTP facility. We've been working on that for a while to maximize the use of some of the machinery there, but currently, we are limited in space.

I can understand that. If you have capped at $100 million there, along with what we get from RTP, the real growth is going to come from materials. Since you've addressed the bull issue, it could ramp up, but until you get Siler City going, I would expect, and please correct me if I'm wrong, that you will see limited revenue growth from materials, even though demand significantly exceeds supply at this time. So, while I'm not looking for guidance, I want to get a reality check on our overall perspective that with low single-digit millions from Mohawk Valley in June, we can expect revenue to be relatively flat or slightly up for most of the fiscal year. Then, as you mentioned, Neill, real revenue growth in 2023 will hinge on the ramp-up of Mohawk Valley. Is that an accurate assessment?

I think that’s right. Ed, we are going to see some modest improvement in materials as we achieve better performance from the longer bull. With the scale we are discussing here, as Durham is capped, the potential of Mohawk Valley is going to be significant. I believe the current utilization at Mohawk Valley is around 15%, which could potentially double our power device revenue capabilities. When Mohawk Valley becomes operational, we should see revenue growth accelerate quickly. If it doesn't, we may remain flat or see modest increases until we start to generate that revenue. However, once we do, we can expect the first $1 million in revenue from a facility that has the potential to exceed $2 billion annually. It has incredible capacity. As I mentioned earlier, everything points to the need to get Mohawk Valley operational, and we are on the verge of doing that.

It's clear that, as you mentioned, the digital and the 1 zero function will likely lead to a decline in margins. As you activate this, you won't see utilization rates anywhere near 30% or 50%, which means there will be some unutilization. I appreciate your clarification on this. I'm trying to understand the situation better because the consensus has been significantly off and continues to be. I want to ensure we are aligned for the rest of the year. Regarding Mohawk, have you provided customers with the product that they are now qualifying, or is that yet to come? Will the revenue be recognized once you hand it over to them for qualification? I just want to get a sense of where we stand on customer qualification for the material from Mohawk Valley.

We provide customers with qualification material once we qualify them, and we have discussed conducting parallel qualifications and some risk orders from Mohawk Valley. There is significant demand for the product, and many customers have expressed interest in being among the first to go through a fast qualification process. Usually, this second qualification requires us to push the customer, but currently, customers are actively requesting to be prioritized, so we expect this process to move quickly.

Our next question comes from Matthew Prisco with Evercore. Your line is now open.

Hey, guys. Thanks for taking the question. Just wanted to drill on gross margins a little bit here. I am surprised with the guide down in March now that the kind of bull issue is behind and revenues kind of guided up modestly. So can you kind of talk about the levers you have for gross margins in the March and into the June quarter? And just to understand when you said before, when you ramp Mohawk Valley, will that be immediately accretive to your non-GAAP gross margins or dilutive? Thanks.

We observed an improvement in yield with the taller bulls, and we needed to align the cycle times accordingly, which we have managed to achieve. However, we still have some leftover inventory from last quarter that we need to work through, which may slightly hinder us. Nonetheless, the fundamental performance for materials, the taller bulls, and the Durham facility, where we faced challenges previously, is expected to improve over the next few months. While there are some lingering effects from these issues, we anticipate overall performance will enhance. Regarding Mohawk Valley, as we ramp up the fab, it will positively impact our non-GAAP gross margins, and we will make adjustments for underutilization to provide a clearer perspective on the fab’s quarterly performance. We will also continue to provide updates on this every quarter.

Got it. That’s helpful. And then as a follow-up, maybe CapEx for the year, given you are spending now in the first half, are you guys still targeting $1 billion net for the year and if so where is that spending going in the second half, can you help us think through what fabs or equipment for shell and all that good stuff?

Yeah. So, yeah, $1 billion for the year. That’s correct. We should see a pickup in the back half of that, we have talked about that before. There’s some expansions that are going on in Durham right now. Gregg talked about turning on portions of the 200-millimeter. We will continue to expand the 200-millimeter substrate capacity on the Durham campus in and around Durham. That’s a big piece of what’s going on now. And in addition to that, we will be working on bringing Siler City to the next phase and getting that facility completed. So I think those would be the bigger pieces. On top of that, we continue to invest in tools in Mohawk Valley and we will continue to tool that out as quickly as we can. So I think those would be kind of the big pieces of what we are going to be spending in the back half of the year.

That’s very helpful. Thanks, guys.

Our next question comes from David O'Connor with BNP Paribas. Your line is now open.

Great. Thanks for taking my questions. And maybe first just on the Mohawk Valley ramp-up and just trying to understand that, if the yields are ahead of your expectations, why the language now is more cautious on the ramp up? Just trying to understand where exactly is the remaining risk and uncertainty, where does that lie with the Mohawk Valley ramp up given that the finishing line is in size here? And kind of related to that as well, so we have a couple of million in the June quarter. How many quarters would it take to kind of hit that $150 million a quarter run rate to kind of get to help meet the like FY 2024 guide? And I have a follow-up on depreciation.

We are taking a cautious approach because we are pleased with the current results. If we try to push too hard too fast, it could lead to unexpected issues. We want to proceed carefully without being complacent. We will push as much as it makes sense, but we don’t want to overextend and cause problems. We are very satisfied with the current outcomes. Let’s move forward step by step, and I believe that will serve us well.

The timing will depend on how many wafer starts we can fit into the fab and ramp up to volume. Once we achieve that, we should see a significant increase in revenue. We have all the necessary components; it's just about fitting them together. We need to ramp the 200-millimeter substrate starts into the fab and enhance the power device back-end performance for testing and inspection. Additionally, we must align with customer schedules regarding material acceptance and monitor all these factors closely. From an execution standpoint, things can progress relatively quickly, but there are numerous variables to consider. We want to approach this cautiously, as there are many components we need to coordinate to launch successfully. We're currently focused on this, and if we can get the fab operational, the economic and technical prospects we see are promising.

There are no further questions. I will pass the call back over to the management team for closing remarks.

Well, thank you for joining us today. I’d like to welcome Stacy Smith to our Board. Stacy is a great addition. He’s got a career that spans many, many years in the semiconductor industry and spans many different functions, including finance roles and operations roles, sales, and marketing roles. So he’s going to bring a wealth of experience to our team and I really look forward to locking arms with them as we move forward here. We are at an inflection point and very near the ramp in production of the world’s first and the world’s largest 200-millimeter wafer fab. We are excited about what it’s doing right now and look forward to continue driving that inflection point forward. Thank you very much for taking the time with us and look forward to chatting with you next quarter. Thank you.

That concludes the conference call. Thank you for your participation.