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Edited Transcript of CREE earnings conference call or presentation 16-Oct-18 9:00pm GMT

Q1 2019 Cree Inc Earnings Call

Durham Oct 18, 2018 (Thomson StreetEvents) -- Edited Transcript of Cree Inc earnings conference call or presentation Tuesday, October 16, 2018 at 9:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Gregg A. Lowe

Cree, Inc. - President, CEO & Director

* Neill P. Reynolds

Cree, Inc. - CFO

* Raiford Garrabrant

Cree, Inc. - Director of IR

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Conference Call Participants

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* Brian K. Lee

Goldman Sachs Group Inc., Research Division - VP & Senior Clean Energy Analyst

* Colin William Rusch

Oppenheimer & Co. Inc., Research Division - MD and Senior Analyst

* Craig Edward Irwin

Roth Capital Partners, LLC, Research Division - MD & Senior Research Analyst

* Harsh V. Kumar

Piper Jaffray Companies, Research Division - MD & Senior Research Analyst

* Hilary Elizabeth Cauley

JMP Securities LLC, Research Division - Associate

* Jeffrey David Osborne

Cowen and Company, LLC, Research Division - MD & Senior Research Analyst

* Jonathan Edward Dorsheimer

Canaccord Genuity Limited, Research Division - MD & Analyst

* Krysten Sciacca

Nomura Securities Co. Ltd., Research Division - Research Analyst

* Paul Coster

JP Morgan Chase & Co, Research Division - Senior Analyst, Alternative Energy, and Applied and Emerging Technologies

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and welcome to Cree's Fiscal Year 2019 First Quarter Earnings Call and Webcast. (Operator Instructions) As a reminder, today's conference is being recorded.

I'd now like to introduce your host for today's conference, Mr. Raiford Garrabrant, Director of Investor Relations. Sir, please go ahead.

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Raiford Garrabrant, Cree, Inc. - Director of IR [2]

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Thank you, Liz, and good afternoon. Welcome to Cree's First Quarter Fiscal 2019 Conference Call. Today, Gregg Lowe, our CEO; and Neill Reynolds, our CFO, will report our results for the first quarter of fiscal year 2019.

Please note that we will be presenting non-GAAP financial results during today's call, and a reconciliation to the corresponding GAAP measures is in our press release and posted in the Investor Relations section of our website.

Today's presentations include 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.

(Operator Instructions) If you have additional questions, please contact us after the call.

Now I'd like to turn the call over to Gregg.

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Gregg A. Lowe, Cree, Inc. - President, CEO & Director [3]

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Thanks, Raiford, and good afternoon, everyone. For today's call, I'll briefly discuss our financial results, after which Neill provide more detail regarding Q1 and our Q2 outlook. After that, I'll provide an update on how each business is performing, along with some highlights from the quarter.

Fiscal year 2019 is off to a great start, with first quarter non-GAAP earnings per share that exceeded the top end of our target range, driven by another quarter of robust growth in Wolfspeed, combined with strong gross margin improvement in LED and lighting. This is an excellent result given the headwinds related to global trade tensions, tariffs and the challenges presented by Hurricane Florence in the U.S. and Typhoon Mangkhut in Asia. While we know there will be some bumps along the way as we execute our long-range transformation plan, Q1 represented another step in the right direction.

I'll now turn it over to Neill to provide more detail on the quarterly results and the outlook for next quarter.

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Neill P. Reynolds, Cree, Inc. - CFO [4]

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Thank you, Gregg. Before I get into the numbers, let me just say how excited I am to be here. Cree is a company with a long history of innovation and an opportunity to drive tremendous shareholder value by executing the strategy laid out by Gregg and the team at the Investor Day in February.

With that, I do need to mention that I will be providing commentary on our financial statements on a non-GAAP basis, which is consistent with the how management measures Cree's result internally. However, non-GAAP results are not in accordance with GAAP and may not be comparable to non-GAAP information provided by other companies. Non-GAAP information should be considered a supplement to, and not a substitute for, financial statements prepared in accordance with GAAP. A reconciliation of the non-GAAP information to the corresponding GAAP measures for all periods mentioned on this call is posted on our website or provided in our press release, along with a historical summary of our other key metrics.

For the first quarter of fiscal 2019, revenue increased 13% year-over-year to $408 million. Our non-GAAP net income increased more than five-fold to $22 million or $0.22 per diluted share. The non-GAAP earnings per share exceeded our target ranges and first call consensus due to strong gross margin performance combined with favorability in OpEx. Our non-GAAP earnings exclude $33 million of expense net of tax or $0.33 per diluted share from noncash stock-based compensation, acquired intangibles amortization, lighting right-sizing costs and other items.

Fiscal 2019 first quarter revenue and non-GAAP gross profit for our reportable segments were as follows: Wolfspeed revenue grew 93% year-over-year and 16% sequentially to $127 million and was above our targets. Year-over-year growth exceeded 50% on an organic basis, when excluding the acquisition of Infineon's RF Power business. Wolfspeed gross margin was in line with our targets at 47.4%. LED Products revenue increased 2% year-over-year but decreased 6% sequentially to $147 million, which was in line with our targets. LED gross margin of 28.1% exceeded our targets as strong factory execution, favorable mix and better-than-targeted ASPs more than offset the lower revenue and tariff impact we discussed on our Q4 call.

Lighting Products revenue was down 10% year-over-year and 7% sequentially to $134 million, which was in line with our targets. Lighting gross margin of 23.2% exceeded our targets and increased 290 basis points sequentially due to better mix, product cost reductions, improved operational efficiencies and being more selective with respect to the business we pursue.

Non-allocated costs totaled $1.5 million for the first quarter of fiscal 2019 and are included to reconcile to our $131 million non-GAAP gross profit for a 32.1% gross margin, which is well above our targets. Non-GAAP operating expenses for Q1 were $104 million and lower than our target, primarily due to good discipline around discretionary spend and the timing of certain R&D projects. As we said previously, our plan is to reinvest the OpEx savings from our lighting restructuring into Wolfspeed, so you shouldn't consider this OpEx level to be the new baseline. I'll provide more detail around that in a moment when providing Q2 guidance.

Our non-GAAP operating income exceeded our targets at $27 million. Our non-GAAP tax rate was 18%, which was slightly higher than our targets due to the higher income.

During the first quarter, cash from operations was $34 million and capital expenditures were $40 million, which resulted in negative free cash flow of $6 million. We ended the quarter with $666 million in cash and investments, 0 borrowed on our line of credit and convertible debt with a face value of $575 million.

Regarding the convert, it was issued with a coupon rate of 0.875% and a conversion premium of 31% or $59.97 per share. This financing is attractive because it allows us to reduce interest expense, lock in at fixed rate, add cash to the balance sheet and is accretive. As a result of the increased cash available to invest and a lower interest rate relative to our working capital line of credit, we will move from a position of incurring net interest expense each quarter to earning net interest income. Also, the risk of dilution is quite modest as our stock price could double from the issue price and the additional shares required would only amount to a few percent compared to the current share count.

Our capital allocation priorities remained focused on expanding capacity in our Wolfspeed business. For fiscal 2019, we still target capital investment of approximately $220 million, primarily driven by expanding Wolfspeed's production capacity to support forecasted long-term customer demand. As we continue to ramp this new capacity, we could have some variability in our initial production yields and factory utilization that may reduce our near-term Wolfspeed gross margins.

Day sales outstanding of 34 was flat compared to Q4. Inventory days on hand of 98 increased 7 days from June and is within our target range of approximately 90 days.

With respect to the tariffs in effect at this time, we target the combined impact will reduce Q2 earnings by $0.03 per share, consistent with prior guidance, and will reduce Q3 earnings by up to $0.05 per share. The additional impact targeted for Q3 relates to tariffs applied to some of our Lighting Products that went into effect in September 24. We are evaluating ways to further mitigate the impact of these tariffs.

We target Q2 company revenue in a range of $398 million to $418 million based on the following segment trends: Wolfspeed revenue up approximately 5% sequentially based on solid growth across our businesses; LED revenue down slightly sequentially as the positive growth trends in our 4 focus areas is more than offset by softer demand in China related to the latest round of tariffs; Lighting revenue down slightly sequentially as we focus on increasing gross margins by improving the mix in our business.

We target Cree's consolidated Q2 non-GAAP gross margins to be incrementally higher, net of a targeted 75 basis point or so reduction from the tariffs. Margins for all 3 segments are targeted to be incrementally higher compared to Q1. We are targeting Q2 non-GAAP operating expenses to be approximately $111 million. The sequential increase in non-GAAP operating expenses is primarily due to higher Wolfspeed R&D and a higher number of days in the quarter as well as a full quarter impact of the annual merit increases that went into effect in September, plus other items. While changes in OpEx can vary from quarter-to-quarter for a variety of reasons, including the timing of R&D projects, marketing spend around trade shows and when IP cases go to trial, our long-term objective remains to drive OpEx lower as a percent of sales, even as we increase our investments in growth initiatives. We target Q2 non-GAAP operating profit to be between $18 million to $23 million. Q2 invested cash and revolver borrowings are targeted to be at similar levels to where we exited Q1. And as a result of a full quarter benefit of the convertible offering, we target net interest income to be approximately $1 million compared to net interest expense of $575,000 in Q1.

We target a non-GAAP effective tax rate of 18% for Q2 and fiscal 2019 and Q2 non-GAAP net income to be between $15 million to $19 million or $0.15 to $0.19 per diluted share. Our non-GAAP EPS target already includes a $0.03 decrease from the impact of the tariffs that went into effect in Q1.

Our non-GAAP EPS target excludes acquired intangibles amortization, noncash stock-based compensation, interest accretion on our convertible notes and other items. Our GAAP and non-GAAP targets do not include the impact of any changes to the fair value of our Lextar investment. Our Q2 targets are based on several factors that could vary including overall demand, product mix, factory execution and the competitive environment.

I will now turn the discussion back to Gregg.

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Gregg A. Lowe, Cree, Inc. - President, CEO & Director [5]

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Thanks, Neill. All 3 of our businesses performed well and demonstrated progress in Q1. Wolfspeed continues to lead the way from a growth perspective, delivering better-than-targeted revenue in Q1, resulting in year-on-year growth of 93% or more than 50% on an organic basis. Wolfspeed gross margins were in line with our targets as the team did an excellent job balancing the challenges of rapidly increasing capacity while maintaining margins. In fact, we accomplished our goal of doubling capacity for power devices and material sales a full quarter ahead of plan. The result is a business where revenues have more than doubled, and gross margins have improved by roughly 20 basis points over the 5 quarters since we embarked on the expansion plan.

We're not stopping there, however, as we plan to double our materials and power device capacity again over the next couple of years to meet growing demand for our products and to expand our leadership position in these technologies.

The Wolfspeed sales funnel is growing rapidly for power devices, materials and RF. In power devices alone, we're engaged with dozens of partners working on projects with a total opportunity well in excess of $1 billion. These projects, which span the time frame of our long-range plan, include segments such as electric vehicle drivetrain, onboard charging, DC-to-DC conversion and charging infrastructure.

Additionally, today, we announced that we have signed another strategic long-term agreement to produce and supply our silicon carbide wafers to one of the world's leading power device companies. This agreement is valued at more than $85 million and covers 150-millimeter silicon bare and epi wafers. The agreement is another validation of our technology and scale advantages in silicon carbide.

Turning to LED Products. The business demonstrated further progress relative to its objective of driving value through greater focus. While LED revenue was in line with our targets and was down a bit quarter-on-quarter, gross margins actually increased quarter-on-quarter to its highest level in almost 2 years. A great execution by the team, combined with the strategy on focusing where our products are differentiated in value, more than offset the effects of lower revenue and tariff-related cost.

During the quarter, we introduced the XLamp XP-G3 S Line, an LED that is optimized for connected lighting. Through innovations and component architecture, this new line can withstand double the number of switching cycles when compared to competing LEDs in its class. This is significant because connected lighting systems will dim or switch off lights up to 10x more often than standard lighting systems.

With regard to Lighting, Q1 demonstrated continued progress in the path to fixing this business. Revenue was in line with our targets, and gross margin was better than targeted. For the third quarter in a row, we have improved gross margins by more than 100 basis points, driven by the factors that Neill touched on earlier. The team has done an outstanding job of improving quality through improved processes. In fact, over the last 3 quarters, we've released 21 new products and shipped over 220,000 of those new products with excellent quality metrics that demonstrate our new processes are paying off.

I recently passed my 1-year anniversary. And as I reflect back, it's very gratifying to see the progress that the team has made. The company has a clear strategic vision, employee engagement has improved materially and execution is improving in all 3 of the businesses. One terrific example of that is in our materials business where we exited Q1 achieving record output, improved yield and shorter cycle times.

Of course, it's important to note that, as we've said many times, progress won't happen in a straight line. I'm really pleased to how we're performing with respect to the things that we control, yet we must acknowledge that there are numerous headwinds facing our businesses in the short term. These include direct and indirect impacts of tariffs in our LED and Lighting business, the impact of trade tensions on the global economy and the seasonality that our LED and Lighting businesses typically experience in the March quarter.

In closing, I'd like to say thanks to all the employees that have helped make my first year here so rewarding and share my belief that we are just getting started in terms of what's possible for Cree.

With that, I'd like to turn it back over to Liz, so we can take any questions you might have.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from the line of Jed Dorsheimer with Canaccord Genuity.

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Jonathan Edward Dorsheimer, Canaccord Genuity Limited, Research Division - MD & Analyst [2]

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Congratulations. Turnarounds are not easy, so it looks like pretty strong results in the face of difficult markets. So I guess first question though, on the Wolfspeed, Gregg. As I looked at this agreement and I talk to charging companies, it's undeniable in terms of the use of silicon carbide. I was wondering if you might be able to provide your perspective on what you think -- how much of the base silicon carbide that's out there is Cree actually supplying?

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Gregg A. Lowe, Cree, Inc. - President, CEO & Director [3]

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So thanks for the comment, by the way, Jed. What I would say is in terms of manufacturing silicon carbide materials, we have something north of 65% share. We're a very strong leading company. And I think over the past year, since we've been expanding our capacity, that leadership has just increased. I think there's a tremendous opportunity for a pretty significant transformation across the entire industry, led by things like electric vehicle and charging and so forth. The advantages that silicon carbide bring to the table are undeniable. And I think the transition to silicon carbide is happening very rapidly. And thus, we're expanding the capacity. As we expand that capacity, it's giving us a scale advantage. That scale advantage is helping us improve yield, which scale plus yield improvement is helping us drive cost down and driving the cost delta between silicon and silicon carbide down as well. And so our mission is really to expand the usage of silicon carbide throughout the industry, and I think the supply agreement is one example of us doing just that.

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Jonathan Edward Dorsheimer, Canaccord Genuity Limited, Research Division - MD & Analyst [4]

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Okay. And Neill, welcome. Look forward to meeting you in person. And I guess, just on the LED Products, historically, margins in that business were almost completely a function of the combination of utilization and just spreading your fixed cost on the number of actual units. Has there been any change in terms of the manufacturing platform from 150 to 200? Or could you give an update on the LED just as a refresher and whether or not we should expect any changes in that margin function as we look forward here over the next year?

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Gregg A. Lowe, Cree, Inc. - President, CEO & Director [5]

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Well, I would -- let me take a shot at that, and I'll see if Neill wants to add any color to it. So we're largely 150-millimeter, and we haven't had a transition to 200-millimeter. And what I would say is the dynamic of that business has changed in 2 contexts. One is our strategy is much more focused, going after segments of the market, the more highly value -- or the technology, the capability and the performance that our LEDs deliver to customers. And I think Q1 is a good example of that, with lower revenue and higher margin and so forth. The second thing that I would say is there is fungibility between the manufacturing assets associated with LED and Wolfspeed. And so we're using that fungibility to increase our capability to drive Wolfspeed's growth. So as we see -- if there's changes in demand on LED or what have you, we've got capability to move that capacity to Wolfspeed. In fact, we're doing that sort of proactively as well. So I don't -- it's -- I don't know that it's so much a utilization issue. Of course, there's elements, I guess, of that. But I would say that the margin of our LED business, the dynamics have changed from maybe 2 years ago to we're more focused on better segments of the market. And to the extent that we choose to do so, we can move some of that manufacturing capability to Wolfspeed.

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Operator [6]

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Our next question comes from Joe Osha with JMP Securities.

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Hilary Elizabeth Cauley, JMP Securities LLC, Research Division - Associate [7]

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This is actually Hilary on for Joe. My first question just kind of follows up on the first Wolfspeed question there and just kind of looking out to next year, how much room there is for further improvement on yields [versus] that added capacity coming from CapEx.

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Gregg A. Lowe, Cree, Inc. - President, CEO & Director [8]

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We think we've got some good room for continued improvement in yield, in cycle times, in manufacturing throughput and so forth. We put our manufacturing organizations, our semiconductor manufacturing organizations, together about, I guess, it was 6 to 9 months or so under 1 leader. That's Rick Mcfarland. He's done a terrific job of getting the team kind of unified, and it's allowing us to go attack things across the broader spectrum of the manufacturing asset. So we had great improvements in cycle time. We had great improvements in yield. We had good improvements in costs in Q1. And we see, for the foreseeable future, a continued opportunity for us to continue driving cost down and adoption of silicon carbide up across the industry. So I think the team's driving really, really hard on that. I think we've made some amazing progress. But I would say we're kind of early with some of the first steps. We have -- there's still a long ways to go, and we have line of sight to some pretty decent further cost reductions.

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Hilary Elizabeth Cauley, JMP Securities LLC, Research Division - Associate [9]

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Okay, great. And then one more for me. Congratulations on meeting your year-end target to double the power capacity. I was just wondering if you could better provide a little more color on what that ramp towards doubling the capacity again might look like.

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Gregg A. Lowe, Cree, Inc. - President, CEO & Director [10]

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I -- it definitely won't be a straight line. There's going to be some incremental things that happen in one quarter and more dramatic things that happen in a different quarter. What we're targeting is over the next 24 months to double that capacity. And so that will have quadrupled our capacity from 18 months ago. So pretty significant and what I would describe as some pretty high step-in. That's a lot of activity, that's a lot of work and I'm sure we'll meet a million challenges along the way. But what I would say is we have that same set of challenges as we doubled capacity over the 18-month time period that we have talked about before. And the team has just done a remarkable job manufacturing, working together with R&D, working together with the product groups to really overcome all those challenges. And so when you look at our business being double from where we were -- when we began this process and yet gross margins being 200 basis points ahead of that, I think that says the team has done a really good job.

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Operator [11]

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Our next question comes from Krysten Sciacca with Nomura Instinet.

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Krysten Sciacca, Nomura Securities Co. Ltd., Research Division - Research Analyst [12]

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My first question has to do -- I would just like a clarification on the $1 billion opportunity you noted for the power devices or the silicon carbide-based power devices. Is that just the overall SAM in the market? Or is that the potential revenue generation, assuming that you win all the design wins with the OEMs that you're currently engaged with?

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Gregg A. Lowe, Cree, Inc. - President, CEO & Director [13]

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Yes, it's definitely not the SAM in the market. It's an opportunity that we have for revenue generation. You don't win everything of that. You don't win all of that. But that is the design activity, the design-in activity that we're currently engaged in at this time. Certainly, the SAM is bigger than that.

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Krysten Sciacca, Nomura Securities Co. Ltd., Research Division - Research Analyst [14]

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Got it. And then maybe -- I know that the tariffs are definitely an impact this year. And maybe if you can just describe some of the remedies or actions that you're taking, either in the shorter term or the longer term, to diffuse the impacts of these tariffs.

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Gregg A. Lowe, Cree, Inc. - President, CEO & Director [15]

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Well, we're looking at a number of different things, and I don't want to go through all the detail on it but, obviously, supply chain is one of them. But really, the important thing is, as these tariffs come up, there's the direct impact that we see. And I think we've done a pretty decent job of minimizing, or at least attenuating, what could have been a much bigger impact than it was. It's looking at $0.03 this quarter, $0.05 in the out quarters. So we'll continue looking at things to continue driving the impact of those tariffs down. And then the second related impact is kind of a secondary impact of just uncertainty that customers have and so forth that's also related to the trade tensions that are going on right now. Our belief is that the tensions will eventually abate, and I would imagine that the U.S. and China will end up figuring out some way to have a trade agreement that works for all parties. In the meantime, we're just -- we're dealing with the headwinds, and I think we've done a really good job.

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Operator [16]

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Our next question comes from Harsh Kumar with Piper Jaffray.

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Harsh V. Kumar, Piper Jaffray Companies, Research Division - MD & Senior Research Analyst [17]

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Two questions for me. Gregg, I was wondering if you could give us some color on how big your materials or wafer business is versus your device business and what do you think the growth rates are for those 2? You don't have to give us exact numbers but even some color would be appreciated. And I've got a follow-up.

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Raiford Garrabrant, Cree, Inc. - Director of IR [18]

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Hey, Harsh, it's Raiford. As you know, we're not breaking that out specifically. It's been a while since we've provided any specifics around that. But I think it's fair to say all 3 of the businesses are showing good growth there, including looking at the RF business with the acquisition of Infineon RF Power business. Materials and power for sure have been showing strong organic growth of late.

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Harsh V. Kumar, Piper Jaffray Companies, Research Division - MD & Senior Research Analyst [19]

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That's a fair point. For my follow-up, can I ask you, Gregg, maybe you could outline for us some of the opportunities that GaN and silicon carbide has perhaps in 5G? I mean the obvious one is the PA that should replace the LDMOS chips with. But are there other opportunities, perhaps in antennas or massive MIMO or some of these clustered antennas that people are talking about?

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Gregg A. Lowe, Cree, Inc. - President, CEO & Director [20]

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Yes. We're looking at all those 3 areas that you had just talked about. Certainly, the power and amplifier side of it is ripe with opportunity. As we engage with customers in that space, they like what we're doing in terms of the technology. GaN and silicon carbide offer some really unique advantages. The fact that ZTE is starting to come back is going to give us a little bit of a lift as well. But we're pretty bullish about that opportunity. And so I think bringing in the team from Infineon and integrating them very, very well has given us a nice tailwind in terms of opportunity to grow that business.

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Operator [21]

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Our next question comes from Brian Lee with Goldman Sachs.

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Brian K. Lee, Goldman Sachs Group Inc., Research Division - VP & Senior Clean Energy Analyst [22]

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Actually, I had 2 on margins, specifically. First one is just sort of a clarification on the outlook for 2Q. Neill, you mentioned consolidated gross margins would be up sequentially, net of 75 basis points drag from tariffs, if I got that right. So you're basically calling out that reported gross margin we should expect to be down sequentially. And then given seasonality and additional lighting tariffs as we head into the new calendar year, what do you think that 75 basis point drag will look like in the March quarter?

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Neill P. Reynolds, Cree, Inc. - CFO [23]

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Hey, just to be clear on that, we said the -- that's net of it. And the gross margin target would be -- would go up sequentially, even after the tariff. So we'll see a bit of an increase on the margins. And then on the tariffs, I think what we said there was, in 2Q, we'll see a $0.03 full impact, which was consistent with what we said previously, and then a $0.05 impact going Q3 and beyond.

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Brian K. Lee, Goldman Sachs Group Inc., Research Division - VP & Senior Clean Energy Analyst [24]

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Okay. So gross margins are up, even with the tariff impact into 2Q?

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Gregg A. Lowe, Cree, Inc. - President, CEO & Director [25]

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That's correct.

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Neill P. Reynolds, Cree, Inc. - CFO [26]

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That's right.

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Brian K. Lee, Goldman Sachs Group Inc., Research Division - VP & Senior Clean Energy Analyst [27]

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Okay. And then just maybe a more bigger-picture question around margins. I know you don't want to break out the mix between how much wafer business you're doing relative to device-based business on the silicon carbide push into Wolfspeed. But can you give us any sense of when we're seeing you sign these long-term wafer contracts with different chip makers, what are the economics for you like in one product class versus another, i.e. are you seeing an appreciable -- are you expecting an appreciable difference in gross margin that you earn as a wafer supplier versus eventually seeing more of a mix shift toward devices?

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Raiford Garrabrant, Cree, Inc. - Director of IR [28]

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Hey, Brian, it's Raiford again. Understand the interest in that question, but that's just an area we can't get specific about for a number of reasons. So I would just point back to what we said at the Investor Day in terms of the long-range goal or the long-range plan for the company is to grow Wolfspeed top line significantly. We talked about roughly almost quadrupling to an $850 million level and also striving for gross margin improvement over that horizon, which factors in all these things we're working on.

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Operator [29]

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Our next question comes from Colin Rusch with Oppenheimer.

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Colin William Rusch, Oppenheimer & Co. Inc., Research Division - MD and Senior Analyst [30]

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Just following up on that question. Can you give us a sense of where you're at in terms of the sales cycle and the progress you're making in getting silicon carbide MOSFETs, diodes and power modules designed into -- in the platforms in the automotive industry at this point?

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Gregg A. Lowe, Cree, Inc. - President, CEO & Director [31]

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I kind of touched on that a little bit. We've got a pipeline in just power itself of greater than $1 billion, well in excess of $1 billion, in all of those different applications associated with electric vehicles. So it's -- I would say that we've got really good traction in terms of engagement with customers. The number of customers that we're working with that are committed to silicon carbide is significantly higher than it was a year ago. And I think the customers -- the value proposition in electric vehicles is really pretty straightforward. If you have a car, an electric vehicle that has a certain amount of battery, if you use silicon carbide versus silicon IGBTs, the car is going to go further on the same charge. Or if you have a car that goes a certain number of miles, if you use silicon carbide, you need less battery for that and -- versus silicon. And so I think the car manufacturers have seen that. They understand it. And it's a huge value proposition because I believe the #1 cost item in electric vehicle is the battery. But there's additional things, too. And that is the size of the inverter goes down pretty substantially as well. And there's not a whole lot of room in cars for all the electronics that goes in there. So when the size of the module goes down by a factor of 2x, 3x, it's also a substantial improvement. And so I think we've got really good traction in that space. The conversion to electric vehicle in the industry has certainly hit a tipping point. You're seeing more and more traction on that. With the challenges that the car manufacturers have with the new emission standards in Europe, WLTP, basically it says not having the option of -- really anymore of having diesel, car companies are really driving more and more to introducing significantly more amount of their platforms being based on battery electric vehicles. So I think it's a great opportunity for us. We've said before that we see this as a multi-decade growth opportunity, and we caught it right at the right spot, I think.

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Colin William Rusch, Oppenheimer & Co. Inc., Research Division - MD and Senior Analyst [32]

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Okay. I'll follow up on that just with some more specifics offline. But changing gears to the Lighting business, can you talk about what the near-term focus areas are for optimizing that business and what the initiatives are over the next 1 to 3 quarters in terms of driving cost out and generating a good -- better cash flow on that business?

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Gregg A. Lowe, Cree, Inc. - President, CEO & Director [33]

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Well, the team really is -- the focus of that business is really straightforward, and that is to fix the business. And that primarily means get the quality of revenue up such that the margin looks like, I would say, a well-run lighting company. We have made significant improvement there. We're now 3 quarters in a row of a couple of hundred or 100 or more basis points improvement in gross margin. We're forecasting for this quarter additional gross margin improvement for the quarter. And that's been done primarily through better quality of product, lower warranty sorts of issues, improved channel alignment and so forth. So I think we have still several, I mean, at least 500 to 700 more basis points of improvement in gross margin in that business just to be sort of normal in lighting. And so I think we've got a lot of opportunity for continued improvement, kind of focused on getting the basics right. I think the team's done a marvelous job over the last year making the improvements. We still have a lot of opportunity ahead of us. That opportunity is -- I'll describe it as more blocking and tackling, and I think the team is really focused on that.

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Operator [34]

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Our next question comes from Paul Coster with JPMorgan.

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Paul Coster, JP Morgan Chase & Co, Research Division - Senior Analyst, Alternative Energy, and Applied and Emerging Technologies [35]

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First off, why does the per share impact of the tariffs increase sequentially?

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Raiford Garrabrant, Cree, Inc. - Director of IR [36]

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Paul, that relates to the latest round of tariffs that went into effect on September 24 that applies to Lighting Products that are coming in from China. So we do -- our Lighting business does source some products from manufacturers in China. And there's about a lag period from when some of the products we have already sourced would hit the P&L. So not much of an impact in Q2, and we've started to feel the effects of that in Q3.

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Paul Coster, JP Morgan Chase & Co, Research Division - Senior Analyst, Alternative Energy, and Applied and Emerging Technologies [37]

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Got it. And then a 2-part question really on the impact this is having on your Chinese counterparts, first of all, your JV. Has it impacted it from a day-to-day perspective, the San'an JV? And are Chinese customers sort of seeking alternative supply chains in view of this tit-for-tat situation?

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Raiford Garrabrant, Cree, Inc. - Director of IR [38]

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The JV impact has been relatively small at this point, the JV sales globally not just in the U.S. And in terms of our customers in China, we did mention the fact that Power LED sales into China have been impacted, both -- we talked about it for Q1 and also I've mentioned that in Q2, demand for [our] LEDs in China for lighting customers there, that export is lower. And that's why we talked about excluding that. Our LED business would probably be up from Q1 to Q2 based on the trends in the 4 focus areas, but the weaker demand because of tariffs is being felt in that business.

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Operator [39]

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Our next question comes from Craig Irwin with Roth Capital Partners.

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Craig Edward Irwin, Roth Capital Partners, LLC, Research Division - MD & Senior Research Analyst [40]

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So Gregg, the first question I wanted to ask us about this $85 million 6-inch wafer contract. Can you clarify for us whether this contract was inked very recently, in the last couple of weeks or if this was maybe signed a number of months ago and you've been waiting for approvals from the customer to press release it? And is there any other color that you can give us on this contract as far as pricing with the move from 4-inch to 6-inch?

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Gregg A. Lowe, Cree, Inc. - President, CEO & Director [41]

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Yes. So a couple of things. This deal was agreed to literally days ago, so within the last few days. So it's not something that's been agreed to any long period of time, so -- and we released it -- we did the press release as soon as we had the wording in the press release agreed. So it's a very new thing. We can't give a lot of details on it. What I would say is it's a multiyear agreement that kind of spans the time frame of our long-term forecast that we set out in the February Investor Day. And you can kind of think of it as a -- there's an element of a pretty decent amount of upfront cash deposit to secure purchase obligations and, obviously, secure capacity from the customer standpoint. The pricing is in line with what we think will drive the model that we laid out in the long-term plan. And recall, as Raiford had mentioned, our long-term plan set to fiscal 2022, we would have a Wolfspeed business in the area of $850 million. And we'd have margin, gross margins, that would be up from where we're at today. So it all kind of lines up with that.

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Craig Edward Irwin, Roth Capital Partners, LLC, Research Division - MD & Senior Research Analyst [42]

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Great. My follow-up question is about your CapEx plans for 2019. Can you maybe refresh for us what you're looking to spend out of Wolfspeed for wafer expansion for your silicon carbide power semis business? And what do you expect to spend for the Lighting and LED business?

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Neill P. Reynolds, Cree, Inc. - CFO [43]

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Yes, we don't relatively break that out. I think our CapEx plan for the year, to invest in Wolfspeed capacity, is kind of the same. I think as things kind of move forward here, what you'll see is that it will be kind of ebbs and flows in terms of the level of long lead time type of equipment that we've already kind of purchased. So I think that will kind of play itself out here throughout the year.

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Operator [44]

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Our next question comes from Jeff Osborne with Cowen.

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Jeffrey David Osborne, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [45]

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Two quick ones. Gregg, on the $1 billion opportunity or pipeline for automotive, can you just talk about what the lag is between when that would start flowing through the P&L? I think most Tier 1 suppliers have about a 3-year lag from when a car goes into production. Is it something similar?

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Gregg A. Lowe, Cree, Inc. - President, CEO & Director [46]

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Yes. I think that's about right. Now some of the things that we're engaged in are -- will be ramping before that. But yes, if we design something in today, it's not going to ramp tomorrow. And 3 years, that sounds probably about right from a ramp perspective.

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Jeffrey David Osborne, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [47]

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Got it. And then how do you navigate the wafer supply agreements like you signed today with the longer-term ambitions of competing with your customers? Is that a tension point?

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Gregg A. Lowe, Cree, Inc. - President, CEO & Director [48]

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You would think it would be but, quite frankly, our -- what we're really focused on is trying to convert the silicon -- the power industry from silicon to silicon carbide, very similar to what happened with bipolar when CMOS came in 30 years ago. And to the extent that we continue expanding our capacity, we'll be able to deliver materials to our customers that are helping drive the adoption of silicon carbide into the power industry. We believe that will expand the SAM of that -- of silicon carbide substantially. And as we expand our capacity and drive scale, we'll get the obvious cost advantages of scale. But in addition, we'll get advantages of faster learning, which drives yield improvements. And we saw that last quarter where we had record output, we had increased yield, which drove lower cost. So we're able to sign these agreements with customers because they like the quality of product that we put out. They like the fact that we're investing in the capacity. And that capacity capability is real today. The fact that we've got something north of 65% share and that we're trying to expand that because we're growing the capacity, I think leads them all to getting comfortable in doing these long-term deals with us. And as you can imagine, we've got another -- a number of other discussions ongoing right now. We're very pleased with the one we just announced. That's a great deal for, we think, both parties. And so we're kind of in a whole new ballgame here where we're really trying to change an industry from silicon to silicon carbide. And the fundamental advantages you get with silicon carbide are exactly the kind of things that people are looking for in terms of efficiency, improved mileage for the same amount of battery and so forth. So I think it's working well for us right now. And we've now announced 2 agreements, the Infineon one 6 or so months ago or so, this one today. We're hoping to have some more in the future. We anticipate we'll have some more in the future. And so I'd just say, just stay tuned.

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Operator [49]

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And I'm showing no further questions in queue at this time. I'd like to turn the call to Mr. Lowe for closing remarks.

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Gregg A. Lowe, Cree, Inc. - President, CEO & Director [50]

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Well, thanks a lot, everybody, for your interest and your time today. We appreciate your interest and support, and look forward to speaking with you again when we report our second quarter results.

Thank you.

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Operator [51]

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Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program and you may now disconnect. Everyone, have a great day.