Wolfspeed, Inc. (WOLF) Earnings Call Transcript & Summary

Good morning, everybody, or good afternoon, wherever you may be. My name is Gary Mobley. I'm one of the senior semiconductor analyst at Wells Fargo Securities. And we're super happy and delighted to have Cree's management team, Neill Reynolds, CFO of Cree; and Tyler Gronbach, Head of Investor Relations for Cree. And with that, perhaps I could start off by asking you, Neill, to give us a little bit of background on Cree for those who aren't well versed in the company and for those who haven't been close to the story for, let's say, the last year or so.

Well, thanks, Gary. First of all, thanks for having us. And it's a pleasure to be here again at the conference, virtually, I guess, this year. Hopefully, we won't be doing that next year. But to give you guys a little bit of an overview on Cree. We're in the process of executing a major transformation that I think is going to help position us to capture a significant market opportunity in electric vehicles and high-voltage power applications, as well as RF base stations as it relates to GaN on silicon carbide. And we do that in our Wolfspeed division in 2 fronts. One is, on the material side where we sell silicon carbide wafers and epi, and we've got a very strong position there at north of 60% market share. And in addition, we do that through our growing chip business that we're currently executing on. And I'll tell you that, that transformation is well underway. I think from a commercial standpoint, we've developed a device-only pipeline on the chip side for approximately $10 billion. We've announced 4 major partnerships on the chip side with various Tier 1s and other auto OEMs. And then we've had approximately -- we signed up approximately $1 billion, maybe a little north of that in terms of long-term agreements related to the materials business on SiC, so that's been a real positive. And then underpinning that, we've had a number of executing items. We've announced a large capacity expansion to meet the market demand. I think we probably talked about that a bit this morning. It's underpinned by our Mohawk Valley Fab that we're currently building in upstate New York with a great partnership with New York. We've done 3 M&A transactions and -- over the last several years. And the latest being the divestiture of our LED division, which we just announced last month to SMART Global Holdings. And then lastly, we've brought in a number of people to augment the leadership team at Cree. Previously, a focus on LED and lighting products, and we've brought in a number of semiconductor industry experts in various parts of the business to help us drive the business. So I think we've had a lot of success so far in transforming the business. But I'll tell you what, it's still early stages, and there's a long way to go. And when you put all of that together, I think what it says is it puts us in a good position to, as I mentioned, capture the market opportunity. If you look at, today, Wolfspeed is, on a run rate basis, roughly $500 million of revenue, less than -- just at the high end of the 30s, just below 40% gross margin. And as you look forward, we've put out an operating model for Wolfspeed. And we believe that with even a modest 5% or so, maybe a little bit north of that, electric vehicle penetration rate in terms of global vehicles sold, we can grow the business from there to about $1.5 billion in revenue by 2024 with north of 60% -- I'm sorry, 50% gross margin, 25% EBIT and roughly 25% free cash flow generation. So between now and then, we have a lot of work to do. As I mentioned, we have a number of items that we've talked -- I've already talked through that we're executing on. But I think there's going to be a shape to how that growth happens. I think right now, we're very much in a transformational investment phase with higher CapEx and OpEx levels. I think as you get out to the '22, '23 timeframe, you start to see that market opportunity arise. It'll align with that pipeline development we've seen. It'll align with the capacity expansion in our Mohawk Valley Fab. Start to see the business really to have an inflection point again in that '22, '23 timeframe, and then eventually get to 2024 at that target model. And I believe at that point, we'll operate at scale, because again, that's only at a roughly 5-plus percent EV penetration rate and there's a long way to go after that beyond 2024. So in any event, that's kind of the summary, Gary, kind of where we're at right now.

I appreciate that background. Just to be clear, the 5% penetration rate, that's on a global SAR -- automotive SAR of roughly, say, 100 million units in that 2024 timeframe.

Exactly.

So 5 million pure battery electric vehicles operating at 600 volts and higher. Is that the basis of the assumption?

That's right. And I think -- but I also think if you go below 600 volts, there's opportunities there. I think the big thing you have to think about in electric vehicles now is not just on silicon carbide helping costs, which it does or efficiency, which it does, but it's also on range. So even as you get into smaller battery types, there's still some opportunity. And there are already OEMs leveraging silicon carbide at lower voltages. Although clearly, the benefits start to scale up as you go beyond 600 volts, as you mentioned.

Okay. And you mentioned the divestiture of the LED business, which I believe is scheduled to close in the first quarter of calendar year 2021. What does that do for Cree's management team or Cree as a company, in terms of R&D focus, management bandwidth and additional silicon carbide and gallium nitride capacity?

I think it's -- well, in terms of capacity, I think, number one, we had a plan to outsource our LED business. We've been working through that. And we found a partner in SMART Global Holdings, who's really going to pick up that same outsourcing plan we have for our LED business, and just pick it up on the same schedule that we had before. And what's good about that is, there's a timeframe between now and 2024 as we think about ramping up our Mohawk Valley Fab in 2022 where we need capacity. So as we outsource that LED business, it will create some more capacity in the interim period for Wolfspeed, which has really been the plan. Now it's great to have found a partner like that, and I think we found a really great home for our LED business inside a company that it's going to do very well in. But the big focus for us is going to be, now we can focus on all those different things we just talked about. Expanding our device pipeline, furthering our focus on capacity. And look, we are going to have elevated OpEx for a while now because we're going to be really focused on R&D initiatives that are going to help us bring products to the marketplace, so we can be in position to meet that ramp as electric vehicles, take -- and other applications, take a bigger slope in the curve as we get out to the timeframe a few years from now.

You mentioned Mohawk Valley, that's a greenfield construction for fab. Where does that construction stand today? And are you on pace for your targeted opening timeframe?

Yes, so far, so good. We've been -- we have a great partnership with the state of New York. I think a very highly capital-efficient model with what we're building up there, upstate New York, I think, the announcement was roughly $1 billion fab, but it's got roughly $0.5 billion reimbursements that we'll get from the state of New York. So we've got a great partnership there. And so far, the schedule's been on track. We expect to be ramping that fab in the calendar year 2022 timeframe. And so far, everything's been on track. And as you say, it was a greenfield fab. We have a -- we started from scratch in terms of raising dirt and now we're going vertical. I had the pleasure of meeting with some of the folks in the state of New York, outside, socially distant, as we start to build the fab just the last 6 weeks. And things are going well. So I think so far, so good, and the schedule's on track.

Great. Glad to hear that. It's one of the more common discussion points that I receive from investors is trying to get a sense for the long-term structure of the industry, specifically sil-carbide for electric vehicles. And so long term, is it going to be a situation as it is today, where you have, you as a silicon carbide player, supplying both materials to your competitors and then competing with your competitors on the power device side? Or where do you see the long-term direction of the industry structure as silicon carbide evolves?

Yes. Well, clearly, it's still, as you say, they're very -- it's still evolving. And it's kind of the early innings of a kind of longer-term growth story. I think what's important for us is that we want to continue to maintain our leadership position in the materials business. And that's important for a number of reasons. And I think that when we started this journey, when Gregg Lowe became CEO, I came in a couple of years ago, when we started this journey, it was really important for us to get silicon carbide out into the marketplace and transition the industry from silicon to silicon carbide. And I think that, that tipping point has occurred. And I think silicon carbide, particularly as it relates to electric vehicles and now other applications has done extremely well, and I think that tipping point has happened. Now with that being said, I think that over time, I think that kind of technology position, the capacity capability that we're going to have is going to be really important, not just for us but to create capacity and capability in the overall industry. However, I do think that over time, the device business will grow faster than the materials business. So over time, the materials business will be smaller. But I also think in terms of capacity and availability of capacity for the industry, that's going to be really important. And then the second thing is that we're driving the cost down on silicon carbide, I think relative -- pretty effectively, and we've made substantial progress already on bringing that cost down. And by bringing that cost down, obviously, it makes that transition for both us and our customers as they -- as OEMs and others make decisions on new vehicle models and those types of things, it -- this makes that decision to use silicon carbide really easy. So I think that's -- for us, at least, I think that's going to be the longer-term position. I think we'll continue to invest in the materials business. I think we want to maintain a leadership position there. But the -- but I think the longer-term growth in the market and within our business is going to be on the chip side.

Gary, just to build on Neill's last point there on the cost curve. What we're seeing now, and people who have gotten super excited about electric vehicles, but as the cost comes down on silicon carbide, and if you look at what's happening with our relationship with Arrow, there are new markets that we're now beginning to enter that maybe a couple of years ago, we didn't even think about, just because of the costs related to production of silicon carbide. So we're very excited about the opportunity in automotive. But at the same time, we're very excited about the opportunity we're seeing with Arrow, where we're entering segments before, because of the efficiency that silicon carbide brings to these new product lines, we see lots of opportunities. So like Neill said, materials is going to be very important, but the aperture on devices is going to continue to open for us as we can bring the cost of silicon carbide down.

Okay. The current revenue now for Wolfspeed, as you mentioned, is about $450 million. Could you give us a sense of how that breaks down between power devices, RF, which I believe is the business you bought from Infineon, and silicon carbide materials?

Yes. So right now, you can think of the business as about half the base, half materials. And from a material standpoint, I think that's kind of expected over the last several years. Although recently, we've seen, with the pandemic, some inventory management by some of our customers. We've worked with them on that. But right now, I'd say, half and half. And then within the device business, you can think about those also being relatively equal. So it's still very early innings on the -- particularly on the device side, from -- going from where we are today to having a more substantial chip business. But I guess, that's really why we focus so much on our design and design win pipeline and driving for the future there. And also ensuring that we've got capacity and capability for our customers going forward. So right now, I'd say -- like I said, half and half. And of that second half, the device business kind of being split between power and RF.

Got you. And then in terms of end market exposure or applications, how would you say the mix is broken down between EV, military and aero, solar, wireless and other end markets?

I don't know if I could get into that level of specificity, Gary. But what I would say is that the -- if you look at the overall Wolfspeed revenue, the auto device business is probably less than 10% of the business right now. So there's a long way to go. Obviously, on the material side, we have a lot of exposure to auto and EVs, but on the device side, it's still relatively small. And then to think about the other application, they all kind of fill in and Cree and Wolfspeed have had a long history in silicon carbide applications. They have a partnership with Arrow. So a lot of the nonautomotive applications are what we're kind of seeing revenue through right now. But over time, we'll see, obviously, the -- and I think relatively quickly, the auto business will eventually take over and be the much bigger part of the business, both on the chip and material side.

Okay. And you guys have been dealing, like so many other semiconductor companies, with the export restriction, focused specifically on Huawei. And I'm guessing that has had a huge impact on the RF side of the business for GaN power amplifiers. But aside from that headwind specific to Huawei, how would you characterize the near-term market conditions and visibility for the Wolfspeed side of the business?

So as you look in the near term, I mean, there's obviously some uncertainty and kind of visibility issues and some things just related to pandemic and recovery. We're not like maybe some of the competitors. We've got a, I think, a relatively narrow set of end market customers and demand right now. I think what we've said, right now, we've seen kind of the bottom in the short term, and we're kind of -- we're seeing some modest growth as we go out into the back half of the year. And I think that's both on the power and the RF side. Although I will say, on the power MOSFET business, we're seeing very strong demands. In fact, I think from a -- right now, I think we're capacity limited. So a lot of the capacity expansion we're doing down in North Carolina continues to limit us. But I think the rest of the business, I think, is kind of recovering and moving along nicely as we kind of expected and we talked about. I think, though, the 1 thing to think about, though, Gary, are getting -- that's kind of in the short term. As you think about like device and pipeline and growth, that's been very active. And I would say that when you think about the inflection point for EVs, and certainly over the last several months and even during the pandemic, we've seen the pipeline grow. And I think a lot of what that's about is, it's hitting on a couple of different things. But I think a big 1 now is on EVs and range. We talk about silicon carbide. We talk about bringing cost down. But as you look at a lot of the models that are coming out today, it really is becoming a competition on the amount of range you can have on electric vehicle. And clearly, you need silicon carbide to do that. So that's what's really, I think, from an automotive standpoint, driving our pipeline. So while I think we're seeing a modest pickup in the business in the short term, I'd say the longer-term prospects and the activity we're seeing in our sales pipeline is, I think, accelerating.

Certainly. Certainly driving anxiety is an impediment to EV adoption, I can speak firsthand to that. I wanted to delve a little bit more deeply into sort of the competitive dynamics as it relates to silicon carbide materials. You have a pretty good customer list. I think STMicro will end up being, if they not -- aren't already today, your largest silicon carbide materials customer. They have some investment in -- well, they own Norstel, which they acquired within the past year. You have a supply agreement with Infineon, which recently announced a purchase agreement with GTAT, and I think they intend to pair that supply of boules with their slicing technology, which they acquired in the past couple of years. And so could you speak to how you see Cree fitting into their silicon carbide materials demand relative to their internal sourcing?

I'll answer the question a little bit more generically about -- these customers we sell to are -- they compete with our customers and we sell to them. And for all of them, I think it makes perfect sense that they'll be looking for alternate supply. We have the largest capacity in the industry. And I think a lot of auto OEMs require alternate supply. So I think it makes sense. And I think -- we certainly respect that. With that being said, I think what works. What that's saying, though, is that there's just going to be more investments for silicon carbide. Secondly, I would say that if you look at where that capacity is going to come from, we're going to play a role in that, and I think, in a pretty big way, just because, one is, we have a long history of doing this. We've announced, I think, the largest capacity expansion in the industry. So -- and we're going to continue to invest in silicon carbide materials technologies, as I talked about before. So I think that will continue to play. I think we'll continue to play a large role in that. Secondly, I think you have to think about the cost curves and the capability. Now given we have a lot of these long-term agreements signed up with these customers, that gives -- silicon carbide is a difficult material to work with, as you know. But one of the most important things is the learning cycles you need to get. As I said, we've been doing this for a long time. When we sign up those long-term agreements and we advance our scale, it allows us to take a lot of these learnings we've had over a number of years and apply them across our entire fleet and then just substantially drive that cost down. Now as we continue to do that, I think that's going to make it -- I think our material supply is going to be very, very competitive for people. Whether that be people trying to do it internally or others trying to get into the industry. I just think we've got a plan here in terms of cost and capability, I think it puts us in a great position.

Okay. Gary, just to add on to what Neill said. I think the way to think about this, because we hear from investors a lot about the concern about the competitive landscape. And I think the way to think about it is, it's more evolutionary than it is revolutionary, from what Neill just described there in terms of how the market will evolve. I think the way to think about this, though, is the fact that the level of commentary around silicon carbide within the peer group has elevated as much as that in the last 9 to 12 months tells us that all boats will rise. It's just a question of -- like we've talked about down the cost curve. And then ultimately, you're talking about a diameter shift coming in the next couple of years from 150 to 200, which will also change the dynamics. So there's a lot in play as it revolves around the competitive landscape.

Okay. And at the time you acquired the Infineon and RF business, I believe that was $150 million per year business roughly, and Huawei was a big customer for those GaN and PAs. Have you seen adoption of gallium nitride from some other 5G base station customers and have -- in other words, have you seen more diversity? Have you seen sort of an upward inflection in that business as the market more fully embraces gallium nitride?

Yes, absolutely. And I think what -- obviously, the Huawei situation creates some challenges for us. We never really had that in our long-term plan. I think we saw the writing on the wall on that one early. But you have to respect that Huawei is a technology leader as it relates to base station technology. And they've essentially been designing on GaN and silicon carbide-based products for many years now. And I think that's just a leader in the technology. And what you're seeing now in both macro and massive MIMO applications, I think all of the other OEMS, we do have d*** good relationships with are moving in that direction. And I think as you start to see more massive MIMO, like I said, there's macro programs as well. But I think evolution for 5G and then massive MIMO really require silicon carbide and GaN on silicon carbide, and we will see that play out. In the meantime, we'll see what stimulus does for the 5G rollout in kind of non-China places. Right now, we've seen that a little bit delayed. But again, I think it's one of these things where it's just a matter of time until some of these start to come back into play. And we should see some solid growth. I think we still got a good RF business there, albeit scaled for something smaller than Huawei.

Got you. Okay. One of the other common talking points that I get from investors is everybody trying to figure out the supply-demand dynamics, looking out into the 2024 timeframe, when you have the full operational benefit of Mohawk Valley when your dirt fabs are fully converted. And so how complex of a model do you have in trying to determine what your potential supply can be out of the 2 main facilities at 150-millimeter? And then how that ranks relative to the overall industry?

Look, I think that when you look at the overall industry, I think there's going to be a period of time, like I've said before, we've reached the tipping point for silicon carbide. We know from the early design and design wins that we've had that there's a ramp coming in that 2022, 2023 timeframe, and there's going to be significant supply. And again, the model we've laid out, Gary, is only at about a 5% EV penetration rate. And I think as on how things are going, when we did that model over a year ago, that seemed conservative. And now I think it seems even more conservative based on the way things are going. So I feel at some point, there's going to be still capacity challenges as time moves on, which is why we really need to get ahead of this, and we really believe in getting that capacity in ahead of that demand. And I think we're well funded to do it. And I think there's a great opportunity out there when we hit that inflection point. It's really going to be a function of 2 things. One is going to be the timing of how the adoption rate happens. But I also think it's going to be a function of driving the cost curves down and expanding the number of applications you get with the silicon carbide. Remember, we did a very -- outside of EVs, we did a pretty significant deal with Arrow to expand our sales capability and footprint. And we just did our 650-volt MOSFET launch with them earlier this year, and it's been really, really successful. I think we've generated well above what our initial plan was on that, over $750 million of opportunities in a relatively short amount of time. So while I do hear sometimes there could be capacity challenges. And look, it's an early industry and how is that going to play out with different competitors, and what's the timing of EV ramps. I think when you get out beyond '22, '23 and you get into '24-plus, it's just -- it's a pretty clear line of sight. And let me say 1 last thing. On Mohawk Valley, and we think about that capacity coming online. When you get out to 2024, when you look at the 4-wall capacity capability at the fab, we have that setup. So that's actually less than 50% of the 4-wall capacity. So I think we've got a long runway. I think we've got ways to manage it on the interim. But from an industry standpoint, I think that capacity constraint at some point in time and maybe for multiple periods is probably likely.

Okay. And correct me if I'm wrong, but the transition -- eventual transition of 200-millimeter versus 150-millimeters, what, a 40% increase in potential capacity? And what is your timeframe in terms of, once the Mohawk Valley Fab opens up, the time to switching over to 200-millimeter?

Yes. So I think when you look at 200-millimeter overall, I think you got to look at the commercial market from a wafer supply and epi supply standpoint. I think that's further out. What we've done with the Mohawk Valley Fab is we've set it up for 200-millimeter capability and then kind of definitely downgrade it to 150. And as time moves on, as we make progress on 200, as we get a better sense for that, I think we'll have some flexibility in terms of how to manage what that transition point is.

Got you. Okay. All right. I think we're running out of time. And so with that, I failed to mention at the top of our discussion, my congratulations in reaching the $10 billion market cap club. If not mistaken, this is the first time you guys have reached that. So congratulations on that front. And with that, I want to thank you for this roughly 30 minutes spent with me and helping all of us better understand the Cree story. So thanks again, guys.

Thanks, Gary. It's always a pleasure to be here. I really appreciate it as well.

Take care.

Thank you, Gary.