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

Good afternoon. Why don't we go ahead and get started? I'd like to welcome everyone to this afternoon's session, day 3 of the 24th Annual Credit Suisse Technology Conference. It really is my pleasure this afternoon to introduce the management team of Cree. I couldn't be happier that they're here supporting the conference this year. We've got Gregg Lowe, the Chief Executive Officer; Neill Reynolds, the Chief Financial Officer; and Tyler, who is, people know, the Head of Investor Relations. We've got about a 30-minute fireside chat presentation format. If you have any questions in the audience because of the virtual setting, please feel free to e-mail to me, and I'll try to incorporate that into my prepared comments. But with that, I wanted to welcome Gregg, Neill and Tyler. Thank you, again.

And Gregg, I'd like to open up these fireside chats with somewhat of a little bit of an open-ended question that allow you to kind of set the stage for the conversation. And as I was preparing questions, it struck me that I can't believe you've actually been at Cree now for 3 years. And when you joined, you said that you had a lot that you wanted to do. A year ago, you talked about refocusing on Wolfspeed and the LED business earlier this year. It's now just Wolfspeed. I'm wondering if you can just spend a few minutes, first, and I know this is a repetitive question, what drew you to the Cree opportunity? But more importantly, what have you done since you've been there and kind of -- and repositioning of the company? And how should we think about the core IP and the core strategy from here?

Well, thanks a lot, John, for having us. And really, it's a very simple thing. When I was looking for something, I was really interested in something that had tremendous differentiation. I was looking for something that had a lot of sort of innovation associated with it. And I was looking for something that was sort of underappreciated or something that kind of needed some fixing. And when I looked at Cree, I saw this gold mine of Wolfspeed technology, silicon carbide, gallium nitride, that were sort of clouded by a lighting business and an LED business. And so as I met with the Board and I started talking about the vision that I had, I was very clear with them, and I said, "Look, I think the future -- the gold mine you have inside this company is buried down below, and we need to rise that up and really take advantage of the tremendous opportunity you have. You've got a technology that's very, very difficult to replicate. It's very difficult to get good at. And we're great at it. We've got 60-plus percent market share of the silicon carbide wafer business in the world. So you've got this tremendous capability. You have this wave of transition from internal combustion engine to electric vehicle." And I told the team -- I told the Board, I said, "There's an opportunity for this company to do something in semiconductors. It happens once every 40 or 50 years, and that has completely transitioned the technology from something to something different." And in this case, it's from silicon to silicon carbide. The last time there was a major transition like this was about 40 or 50 years ago when digital technology went from bipolar designs to CMOS. Everything else has been photolithography and Moore's Law and all. I don't want to say it's not easy, but it's kind of incremental steps. Whereas this is another one of those fundamental changes where 40 years from now, our employees are going to look back and say, "We were there when the power market transitioned from silicon to silicon carbide." So that was the real opportunity. That's what I pitched to the Board, and I think they got excited about it. And then in terms of, so what you've been doing lately? Obviously, the first step was selling our lighting business, and we moved very, very quickly on that. We found a great partner with the IDEAL Industries. And we were able to move that out. That left us with a silicon-carbide-based Wolfspeed business and an LED business. And then what we did with LED is we started transitioning the LED business from a silicon-carbide-based platform to a sapphire-based platform, which then allowed us to move to an outsourced platform. And as we did that, that freed up capacity for our Wolfspeed business, but it also put the LED business in a position to be sold because it was easier to move a business that was on a more standard platform of sapphire than it was to silicon carbide. We've done just that with the announcement with SMART Global. We're really excited about this from multiple perspectives. One is the CEO of SMART Global, Mark Adams, is an LED guy, so he understands the business very well. The team is really excited about being a part of that. So it's important to me that the team is excited about where they're going, and I think that's great. But it also now allows us to be completely focused and be a pure-play power semiconductor company focused on compound semiconductors, silicon carbide, gallium nitride going after a tremendous opportunity with the, what I like to call, the end of the ice age. So the internal combustion engine is going away. So we're in the middle of the end of the ice age, and we're kind of a key component of that.

Well, Gregg, that's a good segue. I mean maybe you can help me and the audience better understand. Clearly, one of the big future drivers for silicon carbide will be the move from internal combustion to EV. But today, if you look at Wolfspeed's auto business, I think it's only about 10% of revenue. So help us understand how you're thinking about the transition in the Wolfspeed business from mostly non-auto to -- I presume it's going to be probably about half auto as you think about your fiscal 2024 kind of targets.

Yes. It will probably be a little bit north of that, in fact, in 2024. If you take a look at the device opportunity pipeline that our sales team has been able to gen up over the past 3 years, and we've done a tremendous amount of work in this area, we now have a $10 billion device opportunity pipeline. Well over half of that is automotive. We've announced design-ins with Delphi Technologies, now BorgWarner; with ZF; with ABB; with the Yutong Group in China. And what I would say is 5 years ago, when customers were looking at transitioning to EVs, Wolfspeed wasn't really focused on this that much, and the cost basis wasn't there. And quite frankly, the supply wasn't there. When we announced the substantial increase in capacity over 1.5 years ago in our plans for growing our Wolfspeed silicon carbide materials business and the device business, it really woke up a lot of the customers in EV, number one. Number two is the value proposition in an electric vehicle for silicon carbide is really simple. Your car is going to go a lot further with the same amount of battery, or you can keep the same range and have a significantly smaller battery. And because batteries are the most expensive things in an electric vehicle, the value proposition is pretty straightforward. I've seen some analysts discussing for every incremental dollar you spend on silicon carbide over silicon in an electric vehicle, you get $3.5 to $7 back at the vehicle level. And I think the automakers are seeing that, and they're going,"We really need to be heading down this path." The last thing that I'd say, John, is 3 years ago, as I was meeting with automotive customers, and you know my background is automotive, I spent pretty much 30 years in automotive both at TI and at Freescale, so I know the industry pretty well. I would say that 3 years ago, when I was meeting with customers, they were debating, "Should I go with silicon or silicon carbide for my inverters?" I think that debate is largely over. In fact, I was just in Europe about a month ago, visiting with a number of different customers. And the feedback I got from them was they've moved to silicon carbide. And now it's a matter of are they going to go with us or some other silicon carbide player because the advantages are just obvious. And so it's an exciting time to be in the business, and I saw you smile a little bit when I said the end of the ice age. It's a mantra that we have inside the company. We're driving the end of internal combustion engine. California just announced they're not going to allow the sale of new internal combustion engine cars post 2030. There's various different countries in Europe that are doing the same thing. And so it's an exciting -- very exciting time to be part of this transition.

Well, Gregg, I'm glad you brought up the $10 billion pipeline because you guys have done a good job every quarter giving investors some metrics around pipeline and design-ins versus design wins. I'm wondering if you could just clarify for me as sort of an outsider looking in, how do I think about design-in versus design win? And when you tell me like last quarter, you had $700 million worth of design-in, does that equate to kind of your fiscal '24 revenue target for Wolfspeed, which I believe is still about $1.5 billion?

It is $1.5 billion. And so we have an opportunity pipeline of $10 billion for Wolfspeed. And what -- that is almost exactly the way it's described. It's an opportunity that we haven't won yet, that customers haven't made a decision. When a customer makes a decision to go with us, and that typically comes in some kind of award letter or an MOU or some kind of semiofficial arrangement, that's called a design-in. The customer has chosen to go with us. They put all their engineering efforts on us. We put all of our engineering efforts on them. We're working together, and we're getting ready to produce products that will go into their production ramps. In the automotive world, that typically goes from a design-in where you're working with customers to ramp can be anywhere from 2 to 3 years. When we ship our initial production product, that's when you convert from a design-in to a design win. And so in automotive, that takes several years. So when we look at our fiscal '24 revenue goal of $1.5 billion and we equate that to what we've been able to design-in at this point, we feel pretty comfortable about being able to achieve that number based on the design-ins that we have today. Now design-ins aren't a linear type thing. They don't always go up every quarter. Sometimes customers push out their decisions. You can -- there's different things. So we'll see lumpiness in the design-in metric. But the fact that we've had 3 solid quarters in a row of design-ins is pretty nice from our perspective. And again, looking forward, you'll see some lumpiness in that, but we feel very, very good about the traction that we've had so far.

Well, Gregg, just sort of clarification to make sure I understand. So the way I should be thinking about this is the pipeline opportunity to design-in probability is a lot lower than the design-in to design win probability, i.e. once you have a design-in, you might be off by a couple of quarters as to when that product is going to ramp, but you're pretty confident it will be ramping some time in the future. Is that the right way?

I think that's very much the way to think about it, especially in the auto industry, because when you get designed in, I mean it's a major commitment. There's tons of resources that get put into that. So obviously, you still have to convert it into a design win, but it really is a matter of when the customer is going to ramp and then getting all these things qualified and getting their systems qualified and all of that kind of stuff. There's a lot of work to be done, but the probability that you're going to convert a design-in to a design win is certainly higher than an opportunity into a design-in.

And then, Gregg, as you mentioned earlier, you guys dominate the silicon carbide space with north of 60% market share. The business today at Wolfspeed is a mix between materials and devices. As you approach that sort of 2024 target model, what does that mix look like? And is there a tension with existing customers as you try to move more material to devices?

So right now, the split between our materials business and our device business, which is our power and our RF business, is about 50-50. Going towards the '24 -- well, when we put ourselves in 2024, that mix will be more heavily weighted towards our device business. And somewhere around 2/3, 1/3, plus or minus a little bit, in that kind of ZIP code is about right. In fact, I think at our Investor Day, we said that of the $1.5 billion of Wolfspeed revenue in 2024, roughly $600 million would be materials and that $900 million would be devices. So plus or minus a little bit, 2/3, 1/3. So that's about the right ZIP code. In terms of tension, what I would say, John, is this is an enormously expanding pie for silicon carbide. So there's lots of device manufacturers that can have pretty significant growth aspirations and not be stepping on everyone's -- it's not like we're all efficient in the same time sort of thing. There's a lot of good competition and healthy competition, but there's -- it's a pretty substantially growing market. And then finally, and this is a really important aspect, our device competitors who are our wafer customers, we have long-term agreements with them. We don't do spot business with them. We have long-term agreements with them. We work with them as real customers. We support them very well. I'm engaged quite a bit with Jean-Marc at ST or Keith at ON Semiconductor, Reinhard in Infineon. These are the companies we've made announcements with. We don't produce silicon carbide and keep the top-shelf stuff for us and sell them sort of second tier. We don't do that. We supply them good, high-quality stuff. The feedback we're getting from them is really solid. And in exchange for them giving us a long-term contract, they get access to good cost curves where we're reducing the cost of silicon carbide. So I'd say there's tension at the device level, and that's very, very normal. But in terms of us being a supplier to them, I think any investor is welcome to talk to anybody about that. But I would say most likely, their feedback is going to be pretty good as a supplier of silicon carbide wafers and [ NPE ] systems to them.

Well, Gregg, this brings up kind of a point that I hear often as a concern. And that is you guys are a dominant player today in what's a relatively niche-y market. To what extent does this thing really starts to accelerate and grow? Does it just invite new competition? And so can you spend a few minutes really talking about the barrier to entry, the moats that you've created. I mean, again, I think there's a view out there that making these wafers is somewhat of a commodity if you just throw enough money at it. I think that's a misperception. There seems to be a lot more technology that goes in even on the materials side [ like ] silicon carbide?

That's exactly right, John. And by the way -- and I'll get into this here in a second. Being the leader, it's really important for us to continue investing and really driving things, so that we stay that later. And there's a huge attitude associated with that, and I'll get into that in a second. But in terms of barriers to entry, first off, there's not a merchant market for silicon carbide crystal growth machines. So you can't go down the street and just go buy something from one of the typical vendors in this space. So the machines that we use for building our silicon carbide crystals are hand built. These machines are like nothing you've seen before. They operate at 2,500 degree C, temperatures that are half the temperature of the surface of the sun. So these are very, very tricky things to kind of manage. And so you're trying to grow something that doesn't want to grow naturally. So you have to force a lot of heat and a lot of pressure in there. So now you're growing a silicon carbide crystal. That crystal can grow into one of several hundred crystal structures. And only one of them is good for a power chip. And so you have to grow it in a very specific way. And so now you're trying to grow this crystal. You're trying to grow it in a specific way. Okay? That's hard to do. Then you have to do it with 0 defects or very, very good defect density. Because in automotive, the chips tend to be big. And if you have a single defect in the area of that chip, the chip won't work. It's not like it will work less or have lower performance. It won't work. And so you get 0 yield. So you need to have very, very good defect density, which we're very good at doing. Now you've grown your crystal. You've done it in a machine that you've built yourself. You've done it in a very specific crystal structure, and you've done it with low defects. Now you need to slice the crystal, not for the faint of heart either because it's the second hardest material on earth. So okay. So now you've done that, and you've done that in a way where you haven't destroyed the crystal itself. Now you got to put epi on it. This is also not an easy thing to do, too. So you have all of these barriers to entry that are kind of technical barriers to entry. The typical way companies try to get over those barriers to entry are to throw money at things. And to throw money at things, you need to hire people to go do that. Well, the total amount of knowledge in the world in silicon carbide is pretty low. So it's not even like there's access to thousands of engineers and scientists that know this stuff. It's a very small pool of people. And obviously, a lot of those people work for us. So you have that as kind of a barrier to entry, too. So all of these things are pretty tough. Now that is all then -- in conjunction with all of that, you have what we're doing as the leader. Now we've got 60-plus percent share of the silicon carbide wafer supply in the world right now. And what we're doing, if we're using that scale advantage to drive the heck out of cost and drive costs down. Our cost per wafer today is substantially lower than it was 3 years ago when we started. And we're still on this part of the cost curve. We haven't gone to an asymptotic situation. We're still on kind of this part of the cost curve in terms of our opportunity. And so we continue to see pretty good cost-reduction capability. So sort of what's happening is we're taking our scale. We're using that to drive cost improvements. We're driving those costs down. We're using those costs to engage with customers on long-term agreements, which give us access to greater scale, which allows us to get lower costs, which allows us to -- it's kind of a flywheel-type effect. And so new entrants into this market are not only faced with technical barriers like you have to build your own machines, you have to operate them at 2,500 degrees C, you have to operate them in a way that it gets a certain crystal, all of those things I've talked about. They have to do all of those things while chasing us down at cost curve. And it's not easy to do. So I think the important aspect of all of this stuff is while we're a leader in all of these pieces, we don't rest on our laurels. We're totally paranoid about everybody, and we pay attention to everything in the market. And we treat it all seriously and say, "If we don't run as fast as we can, somebody will catch up. So let's just keep pushing this thing as hard as we can."

Well, Gregg, on that view of running as fast as you can, how are you trying to manage the potential opportunity set against the CapEx dollars and the R&D dollars? You need to support that growth. And specifically, now that you've divested the LED business, is there going to be an acceleration to some of the capacity plans that you've talked about or the R&D OpEx? Are you going to take some of that $300 million you're getting from the LED business and reinvest it in higher rates back into core Wolfspeed?

Well, absolutely. And so a couple of things here. So number one, in terms of the transitioning of manufacturing resources from LED to Wolfspeed, that doesn't change. We already had a plan to do that. And as part of our deal with SMART was that plan needed to stay intact. And so even with the supply agreement we have, it's basically an intact plan. So that part of the plan doesn't go away. But in terms of reinvesting and investing in R&D, absolutely. And in fact, Neill maybe can add a couple of points of color here, but we'll have an elevated OpEx for Wolfspeed during this transition and actually for quite some time because the opportunity for us to take money, invest it in R&D and expand our leadership position is here for the taking right now. Our ability to attract talent to the company is at an all-time high, and it's for 2 reasons. One is I think our semiconductor engineers see that the world is going from silicon to silicon carbide, and they see that we're on the leading edge. And quite frankly, in this world of everybody's zooming in from every place, you can join our company and not move right now. And we've had several, I mean dozens of people join our company at high levels, and they've been to North Carolina once. And nobody even notices because everyone is on a call. So our ability to attract talent is really at an all-time level right now. So Neill, I don't know if you want to hit more on the elevated OpEx.

Yes. I think clearly, what we want to do is be in position to capture the market opportunity that we talked about. We're going to invest for that. And really, what we've talked about, John, is kind of 3 periods for the business. So what we're in now is what I'd call the transformational phase. We're going to have elevated OpEx and CapEx to support the manufacturing transitions, but also, as you mentioned, higher R&D spend and sales and marketing spend, which should position us to capture that market opportunity. And then as you get out to that '22, '23 time frame when some of -- more of the silicon carbide-based EVs start to ramp up in that period, that's when we start to take advantage of this investment that we're talking about now once we get out to kind of an execution time frame out to that $1.5 billion out in the 2024 time frame. So right now, it's really about an investment mode in the business, CapEx to support manufacturing and OpEx to support the R&D and sales and marketing teams, so we can be there to capture that market opportunity that we talked about.

And Neill, you guys, even without the LED divestiture, have the balance sheet to do what you need to do. The divestiture helps. But I'm kind of curious, I think the way it was structured was roughly half is upfront and half is an earn-out. What are the hurdles for the half that's an earn-out?

Yes. So look, I think what we've done is from an earn-out standpoint is just ensure that the operating targets for the business were very much aligned for both teams. And if you think about revenue and gross margin type of goals as you move out into those periods, so the business performs. And it's very much aligned with what we talked about previously. From a capital standpoint, there's about $50 million upfront, John. And then there's about $125 million note. And a lot of that comes in before the first [ tower ] in our convertible debt is due. So that's not by accident. So I think we're in a really good position here in terms of how the deal was managed both from an operating standpoint but also from a capital efficiency standpoint.

And then, Gregg, clearly, the EV opportunity is the most exciting, but you've got good businesses in the comm space now as well. I'm just wondering if you can talk a little bit about how the current demand environment looks. And as you address that, it's hard to talk about the semiconductor space without bringing up U.S.-China trade tensions. How are you thinking about that? And how is that kind of playing on some of the near-term demand fundamentals?

Well, obviously, with Huawei being out of the picture in the RF business, at least for us, it attenuates a little bit what we can do. And so what we've done is we've taken the technology that we developed for them. And by the way, my last international trip prior to COVID was to China and it was signing a deal with Huawei, where we had a great thing going there. I think, literally, on the flight home was when we heard that we weren't going to be able to ship to them. So we had to kind of reposition that technology for others. And we've done that to a good extent. We've made some pretty good inroads there. And now the real question is how much are the non-Huawei companies going to win outside -- either inside of China or outside of China. And I think that's still kind of TBD. So I would say we've got some good traction there, but I think Huawei being out of the picture definitely attenuates a little bit the aspirations. In terms of China in general, we've got great relationships with all their car OEMs over there. We've got designed into the Yutong Group. We're working with all of them. But we're also aware that there is a big tension between the 2 countries. And I think it's independent as to who the President is. There may be less rhetoric now, but there's certainly going to still be -- there's a lot of work that the 2 countries need to do, and there's some real issues that need to be resolved. So I think that tension is going to be there for a while. So what we've done in our 2024 plan, as we've just said, let's just assume that there's going to continue to be tension. And let's take our expectation of revenue in China in 2024 down. And so we now have -- of our $1.5 billion, less than 10% of that is dependent on China, as an example. Could be some good upside if things change. But quite frankly, the amount of time I spent in Washington dealing with this, I think both sides of the aisle are sort of focused on changing the situation with China. And so I think it's going to be some tension for quite some time. And then the final thing that I would say...

I'm sorry, go ahead.

Yes. I was going to say the final thing that I would say is the other interesting aspect that's developed over the last year or so is our expansion in power outside of automotive. And this is through a joint partnership we have with Arrow, where Arrow is our exclusive distributor globally for our Wolfspeed products. And more importantly, in April of this year, they became the exclusive partner of a new product launch that we had with our 650-volt platform. This is something that I've always wanted to do, exclusively launch with a distributor. Arrow has been a great partner. And in the time between April and September, they identified $750 million worth of opportunity for our single 650-volt platform. Now John, just recall, we kicked this thing off in April. Put yourself back in April. China is still down; U.S. is down; Japan, Europe, worst time in the world to launch a new product. And we launched it anyway together with Arrow, and it generated $750 million worth of opportunity. Some of that opportunity has already been converted into design-ins, and they've been fabulous in it. And this is opportunities in areas where we just wouldn't had a chance to get it. We've got a relatively small sales footprint. If I'm traveling in France with one of our sales guys, I'm in the car with the entire Cree French sales force. So -- yes. So it's a relatively small footprint, but Arrow gives us that big footprint. And that $750 million, they found opportunities in something like 45 different countries. And in 20-plus countries of those 45, we don't even have employees. So it's really been great and a great cooperation with them in this regard.

That's great. Gregg, we're coming up to the end of this session. I wanted to give you a couple of minutes maybe for some concluding remarks. I mean it's clear that you guys have an exciting story. You've refocused the business. You've got a great growth path. What do you think is the most misunderstood about the story? Or where do you think the key value proposition is for investors here?

Well, I think, basically, the company's position in silicon carbide, I think, is well understood. I think the notion that somebody is going to commoditize the silicon carbide business has always been around out there. And we don't just brush it off. We pay attention to it. But we also then focus on driving our cost and driving our quality and driving our capability. And I encourage any investor to talk to any of our wafer customers and ask them about the quality of our materials that you're going to find is pretty good. So I think we've done a good job of not relaxing in the lead but really driving and continue to make our leadership both from a technology standpoint and a cost perspective, very, very high. So I think that all of those technical barriers to entry, combined with this kind of rabid appetite we have for driving our efficiencies higher in that, is a little misunderstood. I think the final thing that I would say is, from a device perspective, we've got pretty much subscale fabs in North Carolina here that are old and antiquated and basically are a cost disadvantage today versus anybody else. All of our wafers are physically handled by humans all the time through the process. And that's just not normal in a semiconductor factory. You have overhead automation and so forth. As we move to New York, that disadvantage goes away. And so the advantage we have as an integrated company having our own wafer capability, combined with a more modern manufacturing facility in New York, is going to be a nice advantage for us, and our customers are really looking forward to that.

A great way to end the conversation. I really appreciate your time. I want to thank everyone tuning in but especially Gregg, Neill and Tyler. And I want to pass along our wishes that all of you, your immediate families and the larger Cree family stay safe and healthy in what's been a very trying 2020. I know I speak for everyone when I say I can't wait for 2021, a wide distribution of vaccine and a return to normalcy.

There you go. Thanks a lot, John. Really appreciate it. Thanks, everybody.

Appreciate it. Thank you.