Wolfspeed, Inc. (WOLF) Q3 2020 Earnings Report, Transcript and Summary

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

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

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

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

Thanks Neill. Picking up on what Neill was just talking about. I'd like to provide additional color on the latest trends we're seeing as we navigate the near term environment. While we cannot predict when Covid-19 will start to subside, we expect to maintain the health measures that we have put in place for the next several months. We are also planning to stagger the return of those employees working from home and don't expect to be back to a more normal operating environment until sometime late this summer. This measured cautious approach is being done to help protect the safety of our people. Our more stringent safety measures coupled with the overall operating environment will present some challenges for us in the near term, but we believe the long term demand remains robust. As we previously mentioned, we're expecting decisions on a significant portion of our roughly $9 billion pipeline in the coming 12-months. As we remain closely engaged with our customers, we are very encouraged by the positive sentiment we're hearing from them, with many of them reconfirming the need for silicon carbide technology. We've also been extremely pleased with how our teams have quickly adapted to the current environment, embracing the use of digital platforms to pursue and win business. The level of engagement is impressive with meetings on our digital collaboration hub totaling more than 1,000 a day, conference calls up fourfold and sales pitches per week of seven times in the last five weeks. This has led to increased sales productivity as our sales team has secured more than 500 designs in awards totaling approximately $400 million in the quarter. We also continue to identify attractive design opportunities and projects at a similar pace as in the prior quarters. This connects nicely with the work we're also doing with Arrow Electronics to build a silicon carbide pipeline, leveraging their massive digital sales footprint. Arrow is digital media operations are the world's largest connect up to 80% of the global engineering community through 30 plus media sites that attract 15 million monthly users and generate more than 50 million page views per month. Additionally, we recently announced with Arrow the release of our new 650 volt silicon carbide MOSFET that will deliver higher efficiency for a wide range of industrial applications and help foster the next generation of onboard EB charging, data centers, energy storage solutions to reshape our cloud and renewable energy infrastructures. This partnership is helping drive the transition from traditional silicon to silicon carbide in the power electronics market and the initial feedback on this new product launch is very encouraging. We also remain encouraged by the tremendous opportunity and recent development in the electric vehicle market, which makes up about half of our pipeline. The most recent report in Goldman Sachs suggests a 4x increase in the total number EVs sold in 2025 versus 2019 and that silicon carbide can be a crucial enabling technology given the cost and range benefits at the system level. Aside from these considerations, there's also been considerable discussion about how the stay-at-home orders around the world have significantly reduced pollution in many major urban markets. This could be another catalyst for easy adoption as countries look to reduce automotive co2 emissions. For example, several environmental ministers from EU countries have circulated an open letter recommending that any Covid-19 stimulus package must have a green component specifically referencing sustainable mobility. If such a measure is enacted, it could accelerate or increase the demand of EVs in that region. Further, we've been maintaining an on ongoing dialogue with our customers to support them through this tough crisis. While our automotive customers are addressing near-term challenges including some temporary shutdowns of their operations due to the outbreak, most have indicated they remain committed to delivering electric vehicles to the market with silicon carbide on their original timelines. Additionally, design and activity for the longer-term programs remains very robust. In 5G, rollouts continue to be delayed but the current crisis has underscored the critical need for strong communications infrastructure and expanded bandwidth. While some countries have delayed 5G frequency auctions in the near term, we firmly believe the global implementation of 5G capabilities is forthcoming and are well positioned to support this transition. Importantly, our pipeline is extremely diversified across automotive, communications, aerospace and defense, energy and many other end markets. We are continuously growing our product portfolio as we release new products we are further expanding the possibilities for us across industries and markets. Lastly, we have a number of long-term material supply agreements in place and are well positioned to continue winning new device business. While we are currently navigating a difficult short-term operating environment like all other businesses, our long-term strategy remains intact. Maintaining our capital expenditure plan underscores our confidence in our vision and ability to emerge as an even stronger business well positioned to capitalize on the long-term opportunities for silicon carbide. We have an experienced leadership team that has implemented rigorous business continuity plans allowing us to effectively balance employee safety with meeting the needs of our customers. Our financial position remains strong with a healthy balance sheet and ample liquidity to fund our current operations and invest for future growth. Our market leading position is grounded in more than 30 years of IT and experience and we firmly believe we are best positioned to lead the market as we drive the transition to silicon carbide and build long-term shareholder value. With that I'll turn it back over to the operator and we'll begin our Q&A session.

[Operator Instructions] Our first question comes from Jed Dorsheimer with Canaccord Genuity. Your line is open.

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

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

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

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

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

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

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

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

And just to add maybe a little bit of color to it. And I know you have a follow-up. And basically a daily basis our factories will see somewhere between 45% and 65% of the normal workforce coming in and so obviously with that it lowers the output that we get for that. We've been very strong and strongly encouraging people who are sick to stay home. And so you have people who would normally sort of just kind of deal with a cold are staying home and that's obviously a positive thing because it continues to limit this spread of the disease any further. We do have some people that are staying at home because they are at higher risk; they have diabetes or some other respiratory condition. We have some folks that are staying at home because their primary caretaker, the elderly folks, of their elderly parents and so forth. So we've got some of that kind of stuff. We are bringing in, we are hiring some people as a replacement there, but we're being very, very not slower, we're being very, very measured in terms of doing that because with 45% to 65% of the workforce in we don't want to just swamp it with a whole bunch of people that don't know how to utilize the machines and the equipment and there. We're taking the people that do know how to do that and put them on and as trainers and so forth. So we're bringing them in a very, very measured pace. In fact, I was in one of the fabs just the other day, I met a new employee that kind of kicked off and moving forward on one of the machines and so forth, but so it's -- there's a number of different things that are impacting this. Bottom line is that all the things are having a positive impact on us stopping the spread of the disease, but they're certainly having an impact on utilization.

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

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

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

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

Our next question comes from Craig Hettenbach with Morgan Stanley. Your line is open,

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

Yes. I could highlight some of that. We just reviewed some of that the other day. So, obviously, this past quarter we had several 100 customers went from opportunity to design in whether kind of committed to using us and super excited about that. And it's totaling around $400 million. Now, obviously, all of those won't eventually go into production. There's always kind of some percentage of that that goes away, but it's a great indication of success and basically when customers do evaluations of this technology, they look at a number of different things. They look at the device performance. We always come out very much on top when it comes to device performance. They look at the supply capability and obviously with the expansion that we have in silicon carbide manufacturing capacity, we come out pretty good there too. From our automotive perspectives, they look at your ability in automotive. Here where we're coming up the learning curve I would say on that. And we've added a substantial amount of capability inside of our team in terms of folks that understand automotive that has been a big help in terms of securing things like Delphi and ZF. So as an example the woman that runs our quality organization used to run automotive quality for a very large semiconductor company focused on automotive. So we're bringing that skill set in. So that's been on the positive side, obviously, we're not going to win everything. And I don't anticipate that we're going to win everything in our $9 billion pipeline in fact, we we'll probably lose a sizable amount of that at the device level. What I would say is in terms of losses sometimes it's not having exactly the right part at the right time. There are times where customers are looking for a ramp that's faster than we're able to handle because of our capacity situation where it is today. And so it goes to somebody else at the device level. What I would tell you is that all of the device losses that I've seen have basically gone to folks that we have very good relationships with in terms of materials. So if we don't win at the device, we tend to win it at the material side of things. I don't know if, Neill, you have any additional color you want to put in there.

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

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

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

Thank you. Our next question comes from Edward Snyder with Charter Equity. Your line is open.

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

Yes, no problem. So first off, we do still see pretty good excitement for GaN on silicon carbide in the 5G space outside of Huawei. So we're engaged with mostly all of the players that you would think you'd want to engage with outside of Huawei and that's been going well and they like what they see in terms of technology, and we are in various different phases of design. And in fact some of the design-ins that we got last quarter was indeed in the RF space for GaN and silicon carbide. But you're right, Ed, we also have a good aerospace and defense business. We've got customers in that area still engaged with us as well. And we see good long-term outlook, but I wouldn't -- I wouldn't characterize the GaN on silicon carbide outside of Huawei as -- I would characterize it as great opportunity. We've got a lot of customers, evaluating the technology. And I think they see the benefit of that technology, especially as it relates to the massive MIMO.

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

It is definitely, yes, it's a wafer diameter move as well. So the RTP factory is 100 millimeter and the Durham factory is 150. So there is a -- there is a change in diameter, but I think it's really fab related and not the underlying technology related. As Neill mentioned, we have made progress on that and so yields are improving. They're just not improving at the rate that we'd like them to or the rate we'd like to get it back up to. Part of that over the last quarter and through this quarter is just simply the output that we're getting through the factory; we're getting less turns through factory, which is not allowing us to get enough learning in terms of the yield input -- improvement. I'd just sit through our yield review just earlier today. There are lots of good things that are going on. We are making improvements we have improvements baked in for this quarter, but it's sort of one step at a time versus a giant -- a giant leap or bigger steps at a time. Just recall these are relatively older factories and so there is not a whole lot of automation. So turning the knobs and making the improvements requires a lot of hand holding. As we move to the Mohawk Valley fab, this is going to be a highly automated sophisticated modern wafer fab. And so when you have issues like this there will be all sorts of process automation that is going to help you. There is going to be data that's going to help you and get through these things in a much faster -- in a much quicker manner.

Thank you. Our next question comes from Craig Irwin with ROTH Capital Partners. Your line is open.

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

Well, thanks for the question Craig. And what I would say is the design-in activity and the addition of new programs to the pipeline and so forth is continuing at the same pace that we saw before, which is really good. The fact that we got 500 design-ins, roughly $400 million this past quarter. I think it's amazing to me, despite the fact that people have been in locked down and so forth. And just as -- just a little factoid about 60% of those wins were automotive related and about 60% were power related that obviously goes together because it's automotive and power. But so we're pretty excited about that. In terms of in near term versus longer term, I would say there is no change on that. Nothing has turned into it's a nearer term opportunity versus a longer-term opportunity. Most of the things that we work on, especially in the automotive space are sort of 2022, 2023 related as we've talked about before with the production ramps for Delphi and ZF in that kind of time frame as well. The only near term impact that we've seen from any of our customers is their ability to get into labs can sometimes be hindered because they are shutdown and so maybe the -- the pace of evaluation might be a little bit longer, but I tell you, I've been on calls with many different customers and engaged with many different customers and they -- I have asked them about, do you think this is going to cause a delay in your ramp up production and almost to a person they've said no, not only will it not cause a delay, but it's probably going to steepen the ramp, because they are focused more on -- and their customers are focused more on the electrification of the powertrain. There is nobody going back and doubling down on internal combustion engine or anything like that. And in fact the automotive customers that I've talked to have said when they look at prioritizing their R&D, they obviously have to make some decisions on that because of what's happening. They are prioritizing electric vehicles and deprioritizing things like autonomous vehicles, at least for the near term because that's sort of autonomous vehicles are further out in time than EVs. And then the final thing I would say is the comments I heard from customers, it's really not lost on people that cities like Los Angeles have blue sky and no pollution for first time in a long time. People living in different parts of the world that are sort of teenagers are seeing blue skies for the first time in their lives. And with the EU push of trying to make any kind of stimulus package associated with the green -- a green sort of recovery and stimulus for electric charging stations and so forth, I think all of our automotive customers are hearing all that, seeing all that and thinking this is going to be an opportunity for them.

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

Yes, it hasn't changed at all by the way. So we're still kind of full systems ahead on that. As it relates to this 100 to 150, it really has nothing to do with the diameter itself or the materials, or the underlying ePi or any of that kind of stuff. All of that is rock solid. We're talking about a change in a fab that's kind of a dated fab its ability to -- our ability to fine tune it is hindered by the lack of automation and so forth. And then, it just happened to come at a time when there is a pandemic where we have 45% to 65% of the people coming in, we're prioritizing material to get the customers and so forth. So I'd say, Craig, there is no change at all in the 8-inch. The intensity at which we're driving 8-inch as well.

Thank you. Our next question comes from Joseph Osha with JMP Group. Your line is open.

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

Yes. Maybe I'll kick it off and just -- just to make sure you understand it. Our demand book is actually pretty decent, it's really trying to get the buyout is more of a challenge for us. So and that's COVID related and somewhat to these deals that we're talking about, but also 45% to 65% of the folks coming in if we were able to build an inventory buffer, I think our customers would be pretty excited about that. I'll let, Neill, talk a little bit about inventory strategy in general.

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

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

We've got good engagements with customers and the Chinese are shifting their incentives more longer-range cars. So I'd say most of their most of the EVs and China are relatively short range vehicles. So they're shifting those to a longer range vehicles and we've got good engagement with a number of different customers over there. In fact, I was over visiting them late December and had some really good meetings with the customers over there. So I think it's just a matter of them turning their cars from something on paper to something they'd be producing. I think the interest in silicon carbide is really high because of the fact that it helps with range. All that being said, I'll kind of repeat what I said earlier, Joe, which is we don't -- we don't see a clear line of sight to trade resolution anytime soon. It seems like -- it seemed like over the last year every other month there was a -- there was kind of an indication that right around the corner. There is going to be something resolved and then it wasn't so we've kind of just we've kind of been in a mode now of it's just kind of be an issue for quite some time. And as it relates to our longer-term outlook, the 2025 plan that we talked about at our Investor Day, while we have a substantial opportunity for China, the amount of revenue that we're going to get in 2024 actually it is less than 10% dependent on China-based revenue. So we've just sort of muted that assuming that there is going to be a longer term -- that this trade resolution won't while the trade issue won't resolve itself anytime soon.

Thank you. Our next question comes from Sidney Ho with Deutsche Bank. Your line is open.

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

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

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

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

Yes, and Neill, correct me if I'm wrong, but I think in terms of power sort of high-single digit percentage of the revenue, low double-digit percentage of revenue is going to be, automotive related. Today it's pretty heavily; well it's pretty diverse across a whole bunch of different customer bases. As we go through the through the coming years and grow our book of business in automotive but obviously grow substantially faster than anything else and becomes a very large percentage of our business out in 2024. But today, call it -- call it 10-ish percent of the revenue in power and so relatively small. In terms of how much is production and how much is kind of ramping and so forth, obviously most of what we shipped in the previous couple of quarters would be more, I would say, production. But as we, as we move forward, we're seeing an increased demand for some of the pre-production runs and prototype builds and things like that and that we talked about that in earlier call, a couple of quarters. And I guess it was last quarter where customers are indicating that they believe the ramp up there and equipment is actually going to be steeper. And so therefore looking for more prototypes earlier. So Neill, I don't know if you want to add any color on that.

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

Thank you. Our next question comes from David O'Connor with Exane. Your line is open.

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

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

Okay. That's quite helpful. Thanks for that. And then maybe just as a follow-up. Going back to the kind of 500 wins, totaled $400 million that you mentioned earlier Gregg, where any of these attributed to Arrow? Or how -- when does the auto part of the equation come in terms of sales? Thanks.

Yes, I don't have the specific breakout. What I would tell you is they are always doing a fantastic job for us. And when we launched 650 volt MOSFET program, we did that I believe we kicked it off April 1 or April 2, and we are way above linearity in terms of where -- what our goal is together in terms of new opportunities and design-ins and so forth. It has just taken off like a rocket. They're doing a great job and this is obviously a really key thing for us because we have a relatively small sales footprint, but were certainly subscale when it comes to a sales and application engineering footprint and they are definitely not. They have the massive scale and also a great digital footprint as well. So we're really pleased with that. I'm sure the -- I'd love to break out specifically, I don't have it. I do know that inside of our distribution channel, they had a substantial percentage of our design wins are design-ins for the quarter. So really good progress there.

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

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

Yes, the pipeline, we have a pipeline that goes -- basically a methodology that most companies use where you have an opportunity where there is just an opportunity out there and when you look at our total pipeline that's where it starts and then you have a design-in, where the customer has chosen to use you. And then we flip it to design win when they give us their first production order. For an automotive company, design-in is probably the most important metric you obviously want to flip it to production, but it flips of production three or four years later. So you really need getting that design-ins early. I wouldn't describe any of the design-ins we've got as kind of turns business. They're all part of that pipeline. So some of them are going to be shorter term a power supply for a server is going to happen faster than an industrial motor, which is going to happen faster than in automotive chip which is going to happen faster than something in Aerospace. So it's all part of the pipeline, we have things that come in and out of the pipeline. All the time and, like I said, not 100% of the things that we -- that we get a design-in will go into production, but increasing the number of design-in is a really positive thing.

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

Yes. Good catch Paul and it's very, very simple. In terms of production there is -- nobody is changing their plans in terms of -- it's going to push out a year or what have you. What's happening is, some of the customers have labs that are shutdown, so their ability to take our part, put in inverter, evaluates it and gives us feedback has been diminished because they can't get into the lab. That doesn't mean they're changing their production date, it's just their decision is going to happen a little bit later because of that. So that's the nuance in that and that's -- that hasn't hit everybody, but it has hit a couple of different customers and I would view that as kind of a one month, two month kind of thing for the evaluation, some customers actually have their labs open and which is great, but now I would say that all the customers that I've talked to have said that their plans haven't changed and some of the customers that we've talked to just simply can't get into their lab. Does it make sense?

Our next question comes from Ambrish Srivastava with BMO Capital. Your line is open.

Hi. Neill, I just wanted to come back to the gross margin kind of completing the loop here from the first question. There are many factors, but if we were -- and obviously the COVID related stuff is very hard to plan for and account for, but if you think about utilization, which is the biggest factor, what is this fall through to the margin from incremental revenues? That was my question. Then I was a little bit confused about the question or the comment on the strengthening in the order book, it doesn't seem that -- that it doesn't seem it is near term that would give you the confidence to say that yes to calendar 2Q would be the bottom and the utilization.

Thanks Ambrish. I'm not sure exactly what the answer on the ball through is only because we have a pretty dynamic portfolio going on right now with a lot of moving pieces with what's in there. What I would say is though that the, if you look at the margins, where we were in 3Q and moving to 4Q that the difference between that 40% and kind of mid-point guide we had is really COVID related and there's different elements to that, whether it be how the employee show up to work like I kind of mentioned kind of 45%, 65% are showing up on any given day, we've changed some of the compensation for different people to ensure things -- people are doing different types of work and we're managing in the staggering of the employees coming in is kind of challenging as well. So I would think of the gross margins as being very much COVID related and once we're able to get back to normal stable operating situation, those will kind of come back up to the normal -- normal basis of where we're at now. As it relates to the order book. I mean, look, we've got pretty good line of sight to what the backlog looks like. And so the backlogs, particularly in the device businesses have strengthened. Now, as you point out with the COVID situation and the uncertainty around recovery, how are those orders is going to play out, how the end customer going to -- demand going to look two or three months from now. That's very difficult to call. But clearly there is visibility to seeing the backlog improve and we saw that prior to the situation getting more dire here over the last couple of months. So I think overall, look, we've got some improvement in the backlog, but again, we just going to have to play by year until we get out to the other thing that covers a bit over the next couple of months.

Okay, that's helpful. From a quick follow-up, could you just -- you said in the prepared remarks, Gregg, that the capacity plans expansion plans are on track. What is the capital outlay for expansion for the next fiscal year please? Thank you.

Yes. Neill, why don't you dive in?

Yes, let me just hit that. We normally give out the annual -- the annual CapEx I think in our next call, Ambrish as we get into our next fiscal year, but if you go back to the Investor Day what we have said is that 2020 will be -- we just said, will be roughly $240 million and our highest investment year from a CapEx standpoint as part of our longer-term plan will be 2021. I think that's why it's really important for us to have the ample liquidity to kind of drive that plan regardless of kind of the outcome is in terms of the recovery from COVID-19. So you can think of a significantly higher CapEx investment coming in '21 and then beyond that, it starts coming down as we start seeing -- the start seeing the benefits from the deal we have, the partnership we have with the -- with the state of New York.

And just a follow-up on that, obviously I'm in contact with a lot of customers. We've had great customer meetings during this time, despite the fact that we can't fly anywhere. And there is a strong desire from our customers to understand what's happening with our plans from a CapEx and not a CapEx from a capital expansion perspective. And so one of the things we do is we show them pictures of Earth being moved around, concrete being poured, I think this past week, it was, if I recall correctly it was 3,000 tons of concrete was poured on the site. So you show them that picture and you say, hey, we just met with our Board and everyone's committed to this plan. So, the capacity that you were banking on us having when you chose us as your supplier is continuing. And then we talk about as well that not only is our Board, just not just saying that, but we also have the liquidity to make it happen in almost any scenario that we can kind of contemplate in terms of what this crisis recovery could look like. There is a very bizarre situation in terms of what's happening in the world. You've got 180 countries are impacted by it, you've got a consensus GDP forecast for Q2 at a contraction that is 3 time to 4 times stronger than any in modern history. In all of the downturns that I've been in the semiconductor industry in my career, I've been able to watch a sports event, go out to a restaurant, get a haircut, have my kids go to school, none of that's happening. And so I think it's, it's what it really translates to us is the near term is going to be super uncertain and so what we're trying to do with our customer is give them certainty that when they chose us as a supplier to ramp up in 2022 and 2023, we're going to be there and that message has really been well received by our customer base. End of Q&A

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

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

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