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

Welcome to this morning's conference call. This call is being recorded today, Tuesday, August 22, 2023. And at this time, all participants are in a listen-only mode. I will now turn the call over to Mr. Steve Ferranti, MACOM's Vice President of Strategic Initiatives and Investor Relations. Mr. Ferranti, please go ahead.

Thank you, Catherine. Good morning, and welcome to our conference call to announce MACOM's acquisition of Wolfspeed's RF Business. Before getting started, I would like to remind everyone that our discussion today will contain forward-looking statements, which are subject to certain risks and uncertainties as defined in the safe harbor for forward-looking statements the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those discussed today based on these risks and uncertainties, which include the ability of MACOM to realize anticipated benefits and synergies of the transaction, successfully designing, supplying, marketing and distributing its products and other business effects, including the effects of industry, market, economic, political or regulatory conditions. For more detailed discussion of the risks and uncertainties associated with the transaction, we refer you to MACOM's filings with the SEC. Management's statements during this call may also include discussion of certain adjusted non-GAAP financial information associated with our recently reported fiscal Q3 financial results. A reconciliation of these numbers back to GAAP can be found in the slide deck posted to the Investor Relations page of our company website. And with that, I'll turn over the call to Steve Daly, President and CEO of MACOM.

Good morning, and thank you for joining our call. As you may have seen from our press release issued this morning, I am pleased to announce that MACOM has entered a definitive agreement to acquire Wolfspeed's RF business. I will summarize the transaction. Jack will review the financial details, and then we'll be happy to answer your questions. As previously discussed, MACOM's strategy is to be a leading supplier of high-power, high frequency and high data rate semiconductor products and solutions. We believe focusing on technology and products that have these attributes will enable us to achieve consistent best-in-class financial results. Our strategy relies on developing innovative technology and products that have high barriers of entry based on proprietary semiconductor processes, advanced packaging, circuit design and system knowledge. Our strategy also relies on using a combination of internal and external semiconductor manufacturing to create differentiation, scale, manufacturing leverage and operational efficiencies. Last year, we became aware that Wolfspeed was considering to divest its RF business. After a thorough analysis, careful financial modeling and a review of our strategy, we concluded Wolfspeed's RF business would be a perfect fit with MACOM. Today, we are excited to introduce this compelling transaction to employees customers, suppliers and investors. Wolfspeed's RF business has a long history of innovation with silicon carbide materials, gallium nitride epitaxy, process development, circuit design and advanced packaging. Additionally, in 2018, Wolfspeed, then known as Cree, acquired Infineon's RF Power business, which added LDMOS products additional engineering talent and manufacturing capabilities. Today, Wolfspeed's RF business is a diverse portfolio with hundreds of products for top-tier aerospace, defense, industrial and telecommunication customers. This acquisition includes design teams and associated product development facilities in Arizona, California, North Carolina as well as back-end production capabilities in California and Malaysia. At closing, approximately 280 employees from these organizations are expected to join MACOM, including 160 engineers. The acquisition also includes Wolfspeed's 4-inch GaN wafer fab facility in Research Triangle Park, North Carolina, which is currently a Category 1A accredited trusted foundry with the Department of Defense. The fab and its associated employees will convey to MACOM in approximately 2 years after Wolfspeed removes certain production lines and equipment that are unrelated to the RF business. And last, as part of the transaction, MACOM will be assigned or licensed a portfolio of over 1,400 patents in patent applications associated with the RF business. Why is this acquisition strategic for MACOM? First, Wolfspeed has developed leading GaN on silicon carbide technology for RF applications, which simply put is the gold standard in the industry. Wolfspeed's technical teams are world-class, extremely experienced, and they will strengthen our product and process development capabilities. Second, Wolfspeed is in production with a wide range of low frequency, high-voltage GaN semiconductor processes, which we do not have, and it would take us years to develop equivalent processes. Recently, we have been focused on adding very high-frequency GaN processes to our portfolio. So to be clear, their process technologies and products are complementary, not duplicative. Third, Wolfspeed's GaN product portfolio is broader and more mature than MACOM's. They are a trusted and established GaN supplier to the industry, and this acquisition immediately enhances MACOM's ability to access, compete and win in the RF power product space. Fourth, we believe combining our respective portfolios engineering and sales teams will significantly increase MACOM's competitiveness in the market, combining our broad CMOS, BiCMOS, SOI and gallium arsenide product portfolio with Wolfspeed's narrower GaN RF portfolio should create new and exciting growth opportunities. And finally, we estimate the RF GaN market size today is approximately $2 billion split evenly between commercial and defense applications, and it is expected to grow to $3 billion by 2027. This acquisition enhances our ability to compete for and win market share in what are attractive performance-driven markets. As Wolfspeed has stated publicly, they currently support a wide range of critical applications, including radar systems and commercial communication systems. In addition to the strategic rationale, we believe the acquisition's financial attributes are compelling for three reasons: one, the transaction is expected to be immediately accretive to our non-GAAP earnings. Two, we expect to achieve a 100% return on capital in about 3 years. And three, it enables expanded growth opportunities while maintaining our long-term gross profit levels above 60%. All our wafer fabs have one common -- one thing in common. They are relatively small with low capital intensity, run very efficiently and can deliver low, medium and high volumes of unique high-end processes. Wolfspeed fab has similar attributes, and we are confident it will meet our operating and financial metrics. Jack will now say a few words about the details of the transaction.

Thank you, Steve. Because it's the carve-out, we have structured the transaction as an asset acquisition. The transaction includes multiple design centers with associated R&D equipment, back-end assembly and test manufacturing capabilities, and the RTP wafer foundry, which is expected to convey after Wolfspeed relocate certain equipment used for other parts of its business. As part of the transaction, we are also entering a variety of agreements including supply agreements, which will ensure MACOM has a secure and strategic supply of silicon carbide substrates and GaN epi. Wolfspeed's RF business most recently generated annualized revenue of around $150 million. Through certain actions to be taken prior to close as well as post-closing synergies, we expect the RF business to be immediately accretive to MACOM's non-GAAP earnings. This acquisition does not change MACOM's long-term gross margin targets in the 60% range. And as Steve highlighted, we expect 100% return of capital employed or return of purchase price in around 3 years. The RF business will be acquired for $125 million, including $75 million of cash paid at closing and $50 million of MACOM common stock issued with certain restrictions. We will be using cash on hand and approximately 700,000 shares of stock for the purchase, taking on no additional debt and only 1% share count dilution. As a reminder, our cash and short-term investment balances at the end of June 2023 were $588 million. We expect to have between $400 million and $450 million in cash and short-term investments after closing of the transaction, subject to its timing. As a reminder, earlier this month, we repaid $121 million outstanding on our term loan debt, and we expect to be net cash, in a net cash position by the end of the calendar year. We believe the transaction stock component has strategic value and aligns MACOM's and Wolfspeed's goals to have a smooth transition, long-term collaboration and ultimately, the creation of further stockholder value. And finally, closing of the transaction is subject to U.S. regulatory approvals, customary closing conditions and is expected to occur in the first half of our fiscal 2024. Now I'll turn the call back to Steve.

Thank you, Jack. In summary, Wolfspeed's focus on scaling its power device and materials business and our focus on growing our RF and microwave portfolio with proprietary technology and products creates the opportunity for a mutually beneficial transaction. We have tremendous respect for Wolfspeed's management team, and we look forward to working together as we manage the complexity of a business carve-out and a fab transition. Our long-term goals are aligned, and we believe the structure of the deal creates a win-win. For additional information, please visit macom.com and download our one-page strategic rationale tearsheet. With that, operator, we're happy to take a few questions.

[Operator Instructions] Our first question will come from Tom O'Malley with Barclays.

Congrats on the acquisition. I guess my first one is, Steve, you went through and talked about the different components of the business. Can you talk about of the revenue you're getting, how much of that is GaN and how much of that is LDMOS? And then the second part of the question is, if you look at the financials of Wolf, the gross margin profile is in the 30s, maybe even in the high 20s could you talk about, one, is the gross margin of the products that you're getting different than that profile? Or two, how could you help improve that so you could keep your gross margin profile above 60%.

Thank you for the questions, Tom. So as you know, we haven't closed the deal, and so it wouldn't be appropriate for us to comment on details associated with the revenue stream that Wolfspeed is currently generating for this business. So I really can't comment on that breakout per se. And then your questions about the gross margins, I think, is a good one. And I think we want investors to focus on a few things. First, this is a tremendous opportunity for MACOM to combine portfolios and create a leadership position in the market. And we also believe we're uniquely qualified to do this and to support Wolfspeed and their goal to essentially exit the RF business. We believe we're able to improve the profitability of the business by some of the things that Jack referred to, including pre-closing and post closing synergies, which effectively means rightsizing the business to be profitable on its expected revenue run rate. So we need to be clear about that. Additionally, when we add all the ways we run the business in terms of adding synergies associated with back-end manufacturing and scale, we believe we can also improve the gross profit margins of the business. Of course, that all has to wait -- we have to wait to see that be delivered, but we're confident we can do it.

Helpful. And you're saying it's accretive at lows, but you've also mentioned on the call some post-close synergies. Is there any way you could kind of size those synergies for us or at least in these early days, give some sort of boundaries for what you would expect to be able to do?

So we won't detail out any post-close synergies and those will be developed in concert with the management team that's joining MACOM. But I think the real hard work in the heavy lift will be done pre-close, where we are working with Wolfspeed to essentially restructure the organization and the way the business will be run and all that work will be done prior to close.

We have a question from Quinn Bolton with Needham & Company.

Congratulations on the [transactions]. Steve, was hoping to follow up on Tom's question. Just any sense you could give us how large the LDMOS portion is? Is that going to be a strategic focus? Will you continue to look to provide LDMOS into the 4G, 5G base station infrastructure? Or are you really going to focus this business on sort of the more exciting and probably higher growth opportunities in GaN on silicon carbide.

Well, I think, certainly, we're very excited about the silicon carbide element of the portfolio and the trends in the industry would suggest that more and more applications are moving from gallium arsenide and LDMOS to GaN on silicon carbide. And so we do recognize that trend. We do believe that over time, customers that care about efficiency, especially at the higher RF frequencies will be most likely selecting silicon carbide. With that said, we still believe that there is significant opportunities for LDMOS and even today in our own business, we sell MOSFETs as well as GaN components and gallium arsenide components. And oftentimes, we have customers, perhaps in avionics or certain military applications that prefer a silicon approach. And so we will now be in a very strong position to effectively offer the best process technology for that application and work with the customers to really select the best for their application.

And then just -- you sort of touched on it in the prepared script, but maybe spend a minute talking about the complementary nature of the two product portfolios. I think you mentioned the Wolf RF business tends to be perhaps a little bit lower frequency. And I think you said higher power, but maybe it was lower power and then just contrast that to what -- where MACOM is focused with its pure carbide and the new high-frequency gain on silicon carbide process that you're beginning to ramp now?

Sure. So I think it's important to recognize that over the past 3 to 4 years, we've been dramatically increasing the size of the portfolio. And we've been doing that not only using external foundries, but also adding new process technologies in our existing fab here in Massachusetts as well as the recent acquisition of a facility in France, which we now refer to as our MACOM European semiconductor center. So after this deal closes, what you'll have with MACOM is essentially 3, 5 fabs. The low fab here will be running all of our discrete diodes which are both gallium arsenide and silicon. We run HMIC technologies, which are glass-based circuits. We also have all different varieties of GaAs [P-Hampton] MOSFET. Of course, we have our 0.14 GaN on silicon carbide process, which we've been bringing up. And we also run indium phosphide lasers. So we have a very high mix fab here in Lowell. When you compare that technology set to our European semiconductor center, what you see there is a small fab that is very, very focused on very high-frequency applications. Their gate length start basically 100 nanometers and go down. Their technology set is gallium arsenide and HEMTs and also GaN. So that is very complementary to what MACOM had prior to that acquisition. And then when you bring in the North Carolina fab, you now have added to our portfolio GaN processes that have gate lengths of 0.45 micron down to 0.15 micron. But what's interesting about these process technologies is they're high-voltage technologies. So they run between 20 and even 50 to 55 volts. We find that very attractive for very high-power applications. So our strategy, as you can see, is to develop a leading portfolio of unique custom high-end processes. And with this technology, we will launch unique high-end products, which will support the margin structure that we're targeting.

And Quinn, this is Jack. And just to clarify the RTP or the North Carolina fab that's not expected to convey until 2 years from now.

I guess, Jack, just to follow up on that. How does that work? Will you sort of enter into a foundry services agreement then for the first 2 years is that fab is still owned and I guess, operated by Wolf until they can get the equipment out and transfer it? Or is there some other arrangement for that fab in those first 2 years?

No, I think what you described is accurate. We've entered into some supply agreements with Wolfspeed leading up to the conveyance of the fab.

And our next question comes from Karl Ackerman with BNP Paribas.

I suppose you wouldn't have bought the Wolfspeed's RF business if you weren't confident in your own 14 Micron galluim [indiscernible] process for MMICs. Could you discuss the design wins of your GaN business today and address the size of that business relative to your Industrial and Defense segment?

Sure. And I think you're referring specifically to the 0.14 micron process we are running here in Lowell. So as you know, we've recently just released that to production. We don't typically talk about design wins or filling an order book per se. But what I would sort of signal is that, that process is just being released and we are just in the stage of sampling customers and approaching customers with the technology. So it's very, very early with regards to that processes contribution to revenue.

I guess, I suppose the Dovetail to the second question, which is, does the [ Xeomic ] acquisition and the acquisition of Wolfspeed's RF business today, to guess you're more focused on a foundry model? Or will you be exclusive for internal manufacturing of GaN and compound semiconductor manufacturing. And as you address that question, how much of your recently closed AMEC acquisition is split between GaAs versus GaN?

So a lot of questions or points in that question. So at a high level, we support a foundry business model even historically, MACOM has had a select number of customers we've allowed to come in and use our fab as sort of pure-play foundry customers. So we do embrace that. The facility in France has a history of also servicing foundry customers, primarily in the space and defense industry across Europe. And as people may know, Wolfspeed is also embraced a foundry business model. So we will continue to support foundry. We think it's an opportunity to create growth for the business. And so we will continue to embrace in service, the historical foundry customers that not only the French fab had but also the Wolfspeed customers in the future. In terms of the breakout of GaN versus GaAs for the French facility, we wouldn't typically break that out in detail. I would say also that MACOM and this was part of my prepared remarks that we do target a balanced approach for external foundries and internal foundries. And in a perfect model, that would be about a 50-50 split in revenue. And I would say today, we're probably pretty close to that. And over certain years, it will swing one way or the other. But recognize that a lot of our high-performance analog products, our highly integrated components using various large U.S. and international foundry. So we will continue to invest in that part of our business as well.