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Edited Transcript of CREE earnings conference call or presentation 30-Jan-19 10:00pm GMT

Q2 2019 Cree Inc Earnings Call

Durham Feb 1, 2019 (Thomson StreetEvents) -- Edited Transcript of Cree Inc earnings conference call or presentation Wednesday, January 30, 2019 at 10:00:00pm 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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* Ambrish Srivastava

BMO Capital Markets Equity Research - MD of Semiconductor Research & Senior Research Analyst

* 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

* Jonathan Edward Dorsheimer

Canaccord Genuity Limited, Research Division - MD & Analyst

* Shek Ming Ho

Deutsche Bank AG, Research Division - Director & Senior Analyst

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and welcome to Cree earnings call for fiscal '19 second quarter conference call. (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to introduce your host for today's conference, Raiford Garrabrant. You may begin.

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

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Thank you, Gigi, and good afternoon.

Welcome to Cree's Second Quarter Fiscal 2019 Conference Call. Today, Gregg Lowe, our CEO; and Neill Reynolds, our CFO, will report on our results for the second 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 will provide more detail regarding Q2 and our Q3 outlook. After that, I'll provide an update on how each business is performing along with some highlights from the quarter.

We delivered excellent results in Q2 with non-GAAP earnings per share that exceeded the top end of our target range, driven by another record quarter for Wolfspeed combined with gross margin improvements in all 3 businesses. This performance is especially gratifying when you consider the current challenges associated with tariffs, global trade tensions and economic uncertainty. And while we're certainly not immune to the turmoil in our served markets, our business is demonstrating the resiliency that shows we're on the right track with our strategy.

I'll now turn it over to Neill to provide more details on quarterly results and 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, I do need to mention that I'll be providing commentary on our financial statements on a non-GAAP basis which is consistent with how management measures Cree's results 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 other key metrics.

For the second quarter of fiscal 2019, revenue increased 12% year-over-year to $413 million, with non-GAAP net income of $23 million or $0.23 per diluted share. The non-GAAP earnings per share exceeded our targeted ranges and first call consensus due to record revenue for Wolfspeed, combined with strong gross margin performances in all 3 businesses. Our non-GAAP earnings exclude $26 million of expense, net of tax, or $0.25 per diluted share from noncash stock-based compensation, acquired intangibles amortization, interest accretion on the convertible notes and other items.

2019 second quarter revenue and non-GAAP gross profit for our reportable segments were as follows: Wolfspeed revenue grew 92% year-over-year and 6% sequentially to $135 million, consistent with 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 47.8%, a 40 basis point increase sequentially. LED Products revenue was slightly ahead of our target at $145 million, a decrease of 5% year-over-year and 1% sequentially. LED gross margin exceeded our targets at 30%, an increase of almost 500 basis points year-over-year and 200 basis points sequentially, driven by strong execution and higher licensing revenue. Lighting Products revenue was slightly ahead of our targets at $133 million, a decrease of 8% year-over-year and 1% sequentially. Lighting gross margin of 25.7%, increased almost 1,000 basis points year-over-year and exceeded our targets, primarily due to product cost reductions, improved operational efficiencies and being more selective with the business we pursue.

Non-allocated cost totaled $5 million for the second quarter of fiscal 2019 and are included to reconcile to our $137 million non-GAAP gross profit for a 33.3% gross margin, which was well above our targets and represents a year-over-year increase of 760 basis points.

Non-GAAP operating expenses for Q2 were in line with our target at $111 million. Our non-GAAP operating income exceeded our targets at $26 million. Our non-GAAP tax rate was in line with our targets at 18%.

During the second quarter, cash from operations was $92 million, and capital expenditures were $39 million, resulting in free cash flow of $53 million. This free cash flow performance was driven by strong working capital management as well as an upfront payment related to our wafer supply agreements.

We ended the quarter with $724 million in cash and investments, 0 borrowed on our line of credit and a convertible debt with a face value $575 million. Our capital allocation priorities remain focused on expanding capacity in our Wolfspeed business.

For fiscal 2019, we still target capital investments 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 margin.

Day sales outstanding of 31 was down 3 days compared to Q1. Inventory days on hand of 102 increased 4 days from September. We target being closer to our target range of approximately 90 days by Q4.

We target Q3 company revenue in a range of $385 million to $405 million based on the following segment trends: Wolfspeed revenue up a few percent sequentially as silicon carbide and gallium nitride adoption continues; LED revenue down approximately 5% sequentially due to normal seasonality; lighting revenue down approximately 10% sequentially also due to normal seasonality.

We target Cree's consolidated Q3 non-GAAP gross margins at approximately 32% based on the following segment trends: Wolfspeed margin is targeted at approximately 48%, an incremental increase year-over-year and sequentially; LED margin is targeted at approximately 27%, an increase compared to the prior year, but down sequentially primarily due to seasonality lower volume and lower licensing revenue; Lighting margin is targeted at approximately 24%, an increase of roughly 500 basis points year-over-year but down sequentially primarily due to seasonality lower revenue.

We are targeting Q3 non-GAAP operating expenses to decrease sequentially to approximately $109 million even as we increase our growth investments in Wolfspeed. 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 Q3 non-GAAP operating income to be between $14 million to $22 million, and we target non-GAAP nonoperating income to be approximately $1 million. We target a non-GAAP effective tax rate of 18% for Q3 and fiscal 2019, and Q3 non-GAAP net income to be between $13 million to $19 million or $0.13 to $0.19 per diluted share. Our non-GAAP EPS target already includes a $0.03 to $0.04 decrease from the impact of the tariffs.

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 Q3 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 over to Gregg.

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

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Thanks, Neill.

About a year ago, we had an Investor Day where we laid out our strategic plan for Cree. At the top level, the plan was straightforward, drive Wolfspeed as the growth engine, focus LED in more differentiated markets and fix the lighting business. In the year since, we have made tremendous progress on all 3 initiatives. Wolfspeed achieved record results in Q2 as revenue increased 92% year-over-year and more than 50% on an organic basis. Wolfspeed gross margins improved quarter-on-quarter and were in line with our targets as the team continues to do an excellent job balancing the challenges of rapidly increasing capacity while maintaining yields.

From our vantage point, it's pretty clear that we've reached the tipping point in the adoption of electric vehicles and the adoption of silicon carbide. Nowhere was this more evident than at the electronica and CES trade shows where I met with numerous automotive OEMs and Tier 1 suppliers who are expanding their electric vehicle product lines. The level of commitment by the OEMs is impressive as a recent analysis by Reuters noted that carmakers have announced plans to spend at least $300 billion on electrification projects.

Within the EV market, the interest in silicon carbide is extremely high because the value proposition is so strong. Utilizing silicon carbide saves space, reduces cooling requirements and allows for a smaller, lower-cost battery. These benefits far outweigh the incremental cost. And with this becoming better understood, the conversation is shifting from the merits of utilizing silicon carbide to ensuring that an adequate supply will be available as EV production ramps. These trends are being validated by our long-term wafer supply agreements, which now total in excess of $450 million. Our most recent announcement with STMicro alone is worth over a $0.25 billion.

Our Power products business continues to develop with a sales funnel that is building very nicely. In Q2, we saw good growth in the total value of projects in the pipeline compared to Q1.

In RF, the wireless telecom market is moving towards GaN, which enables faster 4G and the transition to 5G given the wider bandwidth, higher frequency and higher efficiency. The outlook is very promising, and we are in the process of adding GaN production capacity to meet the increasing demand that we're seeing.

Finally, this past quarter, we reached an agreement with Arrow Electronics, positioning Arrow as the largest global distributor of our silicon carbide power and GaN RF product portfolios. Arrow's global sales force allows us to reach more markets and customers quicker and more efficiently through a proven partner solution.

For LED Products, another quarter of solid execution helped the business make progress on its objective of driving value through greater focus. Gross margins came in ahead of our target, increasing quarter-on-quarter despite slightly lower LED revenue.

At CES earlier this month, Valeo demonstrated their PictureBeam Monolithic LED array solution for automotive lighting. Powered by breakthrough Cree LED technology, this high-definition lighting system combines road marking together with high-performance low-beam and high-beam functions in a single compact solution.

In terms of Lighting, the team delivered another solid result towards the objective of fixing the business as both revenue and gross margin were better than expected. For the fourth quarter in a row, we improved gross margin by more than 100 basis points in Lighting, driven by the factors that Neill touched on earlier. The team has done an outstanding job improving quality through improved processes. In fact, over the last 4 quarters, we've released 30 new products and shipped over 270,000 units of those new products with excellent performance in the field and high levels of customer satisfaction.

In closing, while there is some choppiness in our served markets related to tariffs and global trade tensions and we know there will be some additional bumps along the way, we remain very optimistic about the underlying trends driving the adoption of silicon carbide and gallium nitride.

With that, I'd like to turn it back over to the operator 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 is from Jed Dorsheimer from Canaccord Genuity.

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

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I guess, just looking at the $220 million of CapEx, I was wondering if you could provide any more detail. I mean, with 50% market share in the silicon carbide foundry side of the business or the materials, could you elaborate on how we should think about that $220 million split over the materials device in gallium nitride? Or really, what I'm trying to get at is to understand the velocity of revenue growth that would come from that.

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

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Well, look, maybe I'll take a shot at it. I don't think we're going to give out specific details on the CapEx spend. Obviously, most of the CapEx -- in fact, nearly all of the CapEx is heading into the Wolfspeed expansion as you had noted. What I would say is through the time period of the long-range plan which we rolled out last year, we anticipate actually all 3 of the Wolfspeed businesses growing very, very rapidly. And most likely, the fastest growth is going to come from the materials business, and that's simply because the channels to market are just significantly bigger as we take that technology to the partners that we're signing up. We're going to see growth in all 3 of those businesses. We're expanding the materials capacity. That's rolling out very, very nicely. We're also expanding the wafer fab capability for our own chip business.

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

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And as a follow-up, you brought something up that I find particularly interesting around the conversations with auto OEMs and EVs. And in particular, if you look at the metrics that are kind of limiting adoption of EV, price and range anxiety, are kind of -- rise to the top there. So if charge times are able to reduce the size of battery, I was wondering if you could provide any color. That seems to be a big opportunity to accelerate at that side of the market.

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

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It definitely is. And the conversations with the auto OEMs have been absolutely outstanding. And you're exactly right, range anxiety is a big issue, and faster charge times is a big priority. And if you think about that, faster charge times means transferring a significant amount of energy over a short amount of time. They're going to do that with higher voltages, and that's going to be a natural fit for silicon carbide. So the automakers see the benefits. They're very, very substantial for utilizing silicon carbide over silicon. In electric vehicles, it allows for longer ranges with the same size of battery or a smaller battery at a lower cost. So we're really excited about that. And as I mentioned, I think the tipping point has kind of happened with the adoption of electric vehicles and in silicon carbide. And so really, as I mentioned in the prepared remarks, the discussions are really all about how fast can you build the capacity and expand the capacity.

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Operator [6]

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Our next question is from Harsh Kumar from Piper Jaffray.

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Harsh V. Kumar, Piper Jaffray Companies, Research Division - MD & Senior Research Analyst [7]

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I just had a pretty simple question. Last year, middle point of the year, there were a lot of companies talking about how they want to get into the wafer business for silicon carbide. Gregg or Neill, I was curious right now, 2-man kind of race here, merchant market, how many years does it take for somebody to get in? And let's say somebody, so a country had an option, like China, what they did to LEDs a few years ago and they wanted to make this a mainstream. What kind of time frame would they need to have to even have reasonable wafers in the market? And I have another one.

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

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Well, it's hard to say. I mean, we've been in this business for 30 years, and we've developed this technology over a long period of time. What I would say, Harsh, is a couple of different things. One is this is not sort of a cookie-cutter recipe-type thing that you can just sort of stamp out in a factory. In fact, all of the machines that we use to produce our silicon carbide crystals are -- can build. That is obviously positive from an intellectual property perspective. It obviously holds back our ability to scale it simply because we're building these things ourselves. So it's difficult. It's not like silicon, growing silicon crystals. It's a lot more finicky, if you will. And so we believe that we have a substantial amount of know-how, intellectual property and experience that is going to allow us to continue to have a really unique position in this marketplace. That all being said, we worry every single day about competitors coming in. And so what we're focused on is increasing the adoption and driving cost through scale, manufacturing efficiencies, yield improvements and so forth. I think our manufacturing team, combined with the researchers we have in this area, have done an outstanding job. And then finally, I would say in terms of that cost reduction that we're driving, we're sort of on the steep part of the curve, if you will. And we're driving it very, very rapidly. So we worry about it every day, and we can just control what's in our hands. And I think we're doing a good job at that at this point.

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Harsh V. Kumar, Piper Jaffray Companies, Research Division - MD & Senior Research Analyst [9]

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And then as my follow-up, I think at the Analyst Day you had said that your goal was to double materials capacity and the chip capacity, and then, I think, to double again. You obviously achieved the first part of the goal, I think, a quarter or 2 quarters almost ahead of the time frame. Do you have a time frame for us to think about when you might double or potentially try to double materials business again at least?

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

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Yes. For the -- we actually achieved that doubling of the capacity, and that was for our Power business and our materials business. We achieved that one quarter ahead of schedule. In our last quarterly call, we had talked about doubling the capacity again, and we had mentioned a 24-month-type time frame. Obviously, we're working real hard to try to pull that in, but that's kind of what I have in mind.

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Operator [11]

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Our next question is from Brian Lee from Goldman Sachs.

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Brian K. Lee, Goldman Sachs Group Inc., Research Division - VP & Senior Clean Energy Analyst [12]

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Maybe staying on that line of questioning. Just Gregg, you mentioned at the beginning of the call the $450 million plus of contracted value that you have in hand on the silicon carbide wafer business. So just wondering, at this point, do you feel like you've locked in all the large-scale players? I know we have 2 of them by name and 1 that hasn't been disclosed. But given that backlog status, is it fair to assume you've got the large-scale players in hand or do you anticipate more of these to come? And maybe just some high-level comments on how you see the spot merchant market versus contract landscape evolving. And then your view on just the overall supplier situation for raw materials today versus let's say, 6 months or a year ago?

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

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Well, Brian, we continue to be in discussions with a number of different folks in terms of these long-term agreements. So I would say kind of stay tuned. I think we're not done yet. And I would also say that the more we get into conversations, the more excitement there is about doing these longer-term deals because people are very concerned about having the capacity to meet their plans and so forth. So no, not done with that. In discussions right now. When do they finalize? TBD. But I would say just kind of stay tuned on that. And then obviously, there is a spot market, but we're playing really the long game here. And so for us, we're much more interested in signing up people for longer periods of time because it gives us, as a company, assurance that the capacity we're putting in place is going to be utilized. As Neill mentioned earlier, there's -- you can see our free cash flow. There's a bit of impact on -- from upfront payments associated with that, which is obviously giving us more confidence. And I think it also gives the folks that we're working together with confidence that they're actually going to get that capacity. So I'd say stay tuned. I think we're more interested in these longer-term deals, and that's how we're playing more of a long game here.

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Brian K. Lee, Goldman Sachs Group Inc., Research Division - VP & Senior Clean Energy Analyst [14]

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Okay. No, that's helpful. Maybe just a second question for Neill. You mentioned the potential for the ramp up and yield issues on the silicon carbide side and potential for lower near-term gross margins. Is that being reflected already in the 48% view for 3Q? Or is that still to come? Maybe if you could just give us some sense of timing and magnitude of the impact of these issues and then sort of when they start to subside.

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

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Maybe I'll take a crack at that first and then Neill can add some color. What we're really saying is when you're ramping capacity like this, there's always the possibility that something goes wrong that the new capacity you ramp-up has a yield issue or something like that. That tends to be a temporary-type thing for sure. And so far through the doubling of the capacity that we've had, the team has faced every single challenge and has overcome it. It's actually astounding to me that we've been able to increase the capacity in such a fast fashion and yet maintain the margins. The team is just -- our manufacturing and operations team has just done a marvelous job. We're just sort of giving everybody a heads up, when you're doing this doubling, things can happen and sometimes you can't get through in a quarter or so. I think that's really what that's all about.

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Neill P. Reynolds, Cree, Inc. - CFO [16]

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Yes. Thanks, Gregg. And I totally agree, obviously. In my experience on these things has been when you're ramping capacity, you're shifting utilization around, you're bringing up new technologies, yields are coming up for the first time. That can certainly have a negative impact as you've gone through, and we haven't seen that. I think as Gregg said and I've seen the same thing, is we've seen a really good job by the team kind of managing through that. So I think those are just the temporary type of things that would kind of ebb and flow as we kind of move through. But I feel good about the spot we are right now with the Wolfspeed gross margin. And our expectation is as we grow the business we'd see that start to accrete towards where we thought it would be as we talked about the kind of the long-term plan at the Analyst Day.

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Operator [17]

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Our next question is from Colin Rusch from Oppenheimer.

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Colin William Rusch, Oppenheimer & Co. Inc., Research Division - MD and Senior Analyst [18]

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Can you just provide us any metrics that you can share on the capital intensity for Wolfspeed per dollar of CapEx in terms of what it can generate in terms of revenue?

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Neill P. Reynolds, Cree, Inc. - CFO [19]

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Look, we haven't said the intensity specifically for Wolfspeed. Our goal has been, as we mentioned earlier, putting $220 million of CapEx this year, which I think is about a 14% investment. Over time, though, as we start to expand the capacity, that would -- and drive towards that -- the 2022 goals that we had laid out at Analyst Day, that intensity should lower. So we should see that go down in both percent and dollars as we kind of move forward. So that's kind of the framework to think about it.

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Colin William Rusch, Oppenheimer & Co. Inc., Research Division - MD and Senior Analyst [20]

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Okay, great. And then are you guys taking a view on potential for material wafer shortages in '19 and '20? And how severe might that shortage be?

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Gregg A. Lowe, Cree, Inc. - President, CEO & Director [21]

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Based on the discussions that we're having with these folks through the long-term agreement process, we're going to be running really, really fast to keep up with the demand that's out there through a pretty extended period of time from a wafer perspective. So we're ramping very hard. We talked about doubling the capacity again. We're going to try to pull that in from the 2 years and so forth. But based on the view that we're getting through these long-term agreements that we've signed so far and the potential ones -- in addition, there's going to be potential ones in the future, we're going to be working really hard to keep up with demand.

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Operator [22]

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Our next question is from Craig Irwin from Roth Capital.

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Craig Edward Irwin, Roth Capital Partners, LLC, Research Division - MD & Senior Research Analyst [23]

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So Gregg, when we talk to people across the supply chain, pick a space, right, from the polishing slurries all the way to finished chips, everybody's pointing to demand that could support a fourfold increase in activity year-over-year. I mean, it seems like people have to be very selective about what projects they actually pursue. Can you maybe discuss for us what would have you move faster? And is there anything hanging out there like maybe 8-inch that you're waiting for before you put some of the larger capital to work to capitalize on what's available in this market?

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Gregg A. Lowe, Cree, Inc. - President, CEO & Director [24]

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All of the capacity that we're putting in place is -- all might be the wrong way of saying it. Nearly all the capacity that we're putting in place is going to be 8-inch capable. And so, obviously -- so that is not holding us back. So we're adding capacity and looking at how do we grow that capacity right now, and then eventually, we'll have to transition to 8-inch. So that's not holding us back at all. From our perspective, doing these long-term agreements give us and our partners sort of we're all in this together and we're all agreeing and we're going to all move forward. And I think it's much better handling it this way than the spot market because you just get sort of overreactions in times like this. So we sit down with our partners. We say, "Hey, what do you really need?" There's obviously contractual obligations associated with that need which are pretty tight. And we feel pretty good about that. And as -- I think it was Harsh. He asked earlier about -- it might have been Harsh or Brian, about these long-term contracts and are we kind of done. We're still engaged with a number of different folks, and we would anticipate that we'll have more of these to come.

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Craig Edward Irwin, Roth Capital Partners, LLC, Research Division - MD & Senior Research Analyst [25]

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Great. And then my second question is about bigger picture, right. So you guys are really actively engaged with most sort of technology-oriented guys at the automotive companies that are sort of leaning forward into what's coming. These exact same people are touching technologies like LIDAR and some of them vixel. Although that's a little bit on the edge. Your teams could very easily address things in these adjacent markets. Can you comment as far as whether or not there's potential for M&A on the horizon?

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Gregg A. Lowe, Cree, Inc. - President, CEO & Director [26]

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I don't want to get specific on that. What I would say is we're focused right now on the silicon carbide and gallium nitride adoption in electric vehicles, in solar, of course, the RF transition and so forth. We have shown that M&A can be part of our strategic options as we acquired the Infineon business about 9 months ago or so. And so, obviously, it's going to be a piece of it, but obviously, I can't get any more specific about that.

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Operator [27]

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(Operator Instructions) And our next question is from Ambrish Srivastava from BMO Capital Markets.

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Ambrish Srivastava, BMO Capital Markets Equity Research - MD of Semiconductor Research & Senior Research Analyst [28]

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Gregg, I just wanted to talk a little bit about or get more perspective from the long-term agreements that you're signing up. Actually, there are multiple customers. But what's the right way to think about the timing for these?

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Gregg A. Lowe, Cree, Inc. - President, CEO & Director [29]

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Well, we don't give out specifics. But I think if you just kind of rule of thumb about a half a decade, you're going to be on the right zip code.

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Ambrish Srivastava, BMO Capital Markets Equity Research - MD of Semiconductor Research & Senior Research Analyst [30]

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Okay. And then my follow-up then is you talked about the pipeline in the device side in the last earnings call, and if I remember correctly, you said $1 billion. Where exactly is that breaking out between? Is it on the inverter side more, on the charging side or on the infrastructure?

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

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On the power side of it, we're seeing some pretty good flow in both inverter and in charging, and most of the growth that we're seeing is associated with electric vehicles. So it's pretty solid and it's pretty substantial right now. We feel very, very good about the pipeline.

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Operator [32]

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Our next question is from Jed Dorsheimer from Canaccord Genuity.

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Jonathan Edward Dorsheimer, Canaccord Genuity Limited, Research Division - MD & Analyst [33]

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Just a follow-up. Gregg, just with respect to the tightness in the markets, and I'm sure you've looked at this. But could you provide any insight in terms of the fungibility associated with the LED business and the Wolfspeed business with respect to lead time and as well as maybe some greater clarity on switch out costs associated with that?

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Gregg A. Lowe, Cree, Inc. - President, CEO & Director [34]

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Sure. From a material base wafer or silicon carbide wafer perspective, the fungibility is extremely high and extremely fast, so we can move crystal growth capability from one to the other pretty, pretty readily and be up in production and running and turning that into revenue very, very quickly. So that's highly fungible and relatively fast. From a wafer production standpoint, that is also highly fungible. Between the 2, I don't -- I can't give you the exact percentage, but a very, very high percentage of these tools are going to be very similar. There, of course, you have to go through a process of qualifying a product in a different fab and so forth, so it takes a little bit longer. We were able to qualify very recently some power products in another line that was running in the LED fab. So we're seeing a little bit of relief right there. But yes, obviously, that takes a lot more work. And you got to get qualification and you got to get customer approval. All these sort of things. So in both instances, the capacity is highly fungible, in one, it ramps a lot faster.

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Jonathan Edward Dorsheimer, Canaccord Genuity Limited, Research Division - MD & Analyst [35]

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Got it. So just when we look at whether it's 3, 4 or 5, whatever the demand increase on that logarithmic curve is based on EVs, the $220 million plus, you could essentially shutter the LED to half that capacity, keep that at 100% utilization and shift that over within a quarter or 2, correct?

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Gregg A. Lowe, Cree, Inc. - President, CEO & Director [36]

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I don't know about the quarter or 2 from customer acceptance and so forth, but yes, we can shift that over. Timing guys really need to think through, but it's probably a little longer than that.

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Operator [37]

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Our next question is from Harsh Kumar from Piper Jaffray.

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Harsh V. Kumar, Piper Jaffray Companies, Research Division - MD & Senior Research Analyst [38]

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You guys have been executing really well. Margins have been going up nearly each quarter. Are there any short-term or even midterm goals, Gregg, that you might have? Particularly curious about the lighting business.

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Gregg A. Lowe, Cree, Inc. - President, CEO & Director [39]

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Yes. And maybe you can hit first, Neill, on lighting, near term.

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Neill P. Reynolds, Cree, Inc. - CFO [40]

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Yes. Just on lighting, so if you look at lighting right now, I think -- first and foremost, I think the team has made, as we mentioned very, very good progress on cost and the quality and distribution. So we think that's going well. I also think that the -- managing the order book and pursuing better kind of orders and quality of orders has been going well. Not a straight line, it goes -- the business will go down seasonally into 3Q. The margin will kind of follow that. And as you kind of think about it going forward then, the revenue and price easily go back up as you kind of go later, and then the margins would continue. So that's kind of -- continue to go up. So that's kind of the way we're thinking about the business at least in the short term.

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

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And then the other thing I'd add to that on the lighting business, if you were to take a look at the new products in the pipeline that we've got out there, and there's a whole bunch of new products that the team is working on, 100% of those new products will have a margin that's above where we're at today. So obviously, as those things begin to ramp, it'll -- the mix will be favorable for us.

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Operator [42]

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Our next question is from Sidney Ho from Deutsche Bank.

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Shek Ming Ho, Deutsche Bank AG, Research Division - Director & Senior Analyst [43]

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So on the Wolfspeed margin, you're not too far from your long-term target of 50%, but you've been bouncing around 47%, 48% in the past few quarters. Can you help us understand what are some of the factors that can push you to 50% or beyond? Is it just a matter of volume? And do the long-term agreements that you signed up have any impact on gross margin one way or another?

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Gregg A. Lowe, Cree, Inc. - President, CEO & Director [44]

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Yes, we're -- obviously, the long-term agreements are in line with our target of growing our gross margin up a couple of hundred basis points and into that low-50s kind of area. So we feel very, very comfortable with that. The team, we're on the steep part of the curve in terms of driving costs down. Team's working on that really, really hard. And we're pretty bullish that we're going to be able to hit the gross margin targets that we've set out to over the long-range plan. As Neill mentioned and I talked about a little bit, when you're ramping like this, sometimes you can have a temporary setback. We haven't had that at this point because the team's just executed so well. So if we have a temporary setback, we'll deal with it, but it will be temporary, and then we'll be marching forward and growing that gross margin as we grow the business.

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Shek Ming Ho, Deutsche Bank AG, Research Division - Director & Senior Analyst [45]

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Great. Then my follow-up question is, I think you guys talked every quarter about the gross margin by segment. Do you have plans to talk about operating margins by segment? I'm trying to figure out if most of the operating profit today is generating from Wolfspeed and whether the LED and Lighting business actually generate positive operating margins as well at these levels and maybe if tariffs has had an impact. And maybe what are you targeting operating margin by segment in the longer term?

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Neill P. Reynolds, Cree, Inc. - CFO [46]

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Look, we're always looking internally, obviously, about how we're running the business. We haven't disclosed that externally. But we think that in terms of the revenue and the gross margin information we give out is kind of a good indicator for both how we manage the business internally and about how we think about it moving forward. So at this point, I think we're pretty comfortable with the way that we're kind of communicating how the business is operating.

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Operator [47]

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Our next question is from Ambrish Srivastava from BMO Capital Markets.

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Ambrish Srivastava, BMO Capital Markets Equity Research - MD of Semiconductor Research & Senior Research Analyst [48]

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I had a quick follow-up on the modeling side, Neill. Is there any change to the out-quarter tariff impact versus what you have guided to in the past given there have been some new -- if I remember from the last earnings call, there has been some new tariff rules that have come in effect?

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Neill P. Reynolds, Cree, Inc. - CFO [49]

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Yes. Thanks, Ambrish. Yes, so we said, I think last time a little bit higher. So right now, we're at $0.03 to $0.04 for both 3Q, and then $0.03 to $0.04 for 4Q is kind of thinking about that at the back half of the year. It is better by a little bit. And really, this relates to some of the work we've been doing with customers and work on the supply chain. So the team's spending, obviously, a lot of time and is managing it. So I think as the -- as news comes out and it's communicated about when the tariffs will hit and what will be the impact, we think we've got that kind of fully baked in with those numbers. Right now, I think the way to think about it, also on the gross margin side, I kind of mentioned that, is inside our guidance now, there's about 80 basis points of pressure from tariffs. So I think we've got that one pretty well identified.

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Ambrish Srivastava, BMO Capital Markets Equity Research - MD of Semiconductor Research & Senior Research Analyst [50]

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Okay. And that was 75 bps in the last time you gave guide, right?

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Neill P. Reynolds, Cree, Inc. - CFO [51]

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Yes. It's about 75, 80 bps, yes, in that range.

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Operator [52]

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At this time, I am showing no further questions. I would like to turn the call back over to Gregg Lowe for closing remarks.

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Gregg A. Lowe, Cree, Inc. - President, CEO & Director [53]

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Thank you, Gigi, and thank you, all for your time today. We really appreciate your interest and support, and look forward to speaking with you again when we report our third quarter results.

Thank you, everybody, and good night.

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Operator [54]

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Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may now disconnect.