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Edited Transcript of CREE earnings conference call or presentation 20-Aug-19 9:00pm GMT

Q4 2019 Cree Inc Earnings Call

Durham Aug 27, 2019 (Thomson StreetEvents) -- Edited Transcript of Cree Inc earnings conference call or presentation Tuesday, August 20, 2019 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

* Tyler D. Gronbach

Cree, Inc. - VP 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

* Jamison Yeol Phillips-Crone

BMO Capital Markets Equity Research - Associate

* Jeffrey David Osborne

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

* Jonathan Edward Dorsheimer

Canaccord Genuity Corp., Research Division - MD & Analyst

* Joseph Amil Osha

JMP Securities LLC, Research Division - MD & Senior Research Analyst

* Paul Coster

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

* 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 the Cree Fourth Quarter Fiscal Year 2019 Earnings Conference Call and Webcast. (Operator Instructions) As a reminder, this conference call may be recorded.

I would now look to introduce your host for today's conference, Mr. Tyler Gronbach, Vice President of Investor Relations. Sir, you may begin.

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Tyler D. Gronbach, Cree, Inc. - VP of IR [2]

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Thank you, Daniel, and good afternoon, everyone. Welcome to Cree's Fourth Quarter Fiscal 2019 Conference Call. Today Cree's CEO, Gregg Lowe; and Cree's CFO, Neill Reynolds, will report on the results for the fourth quarter of fiscal year 2019.

Please note that we will be presenting non-GAAP financial results during today's call, which is consistent with how management measures Cree's results internally. 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 to the most directly comparable GAAP measures is in our press release and posted in the Investor Relations Section of our website, along with a historical summary of other key metrics.

Today's discussion includes 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 any additional questions, please feel free to 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, Tyler, and good afternoon, everyone. We delivered a solid performance in Q4 with non-GAAP earnings per share at the top end of our updated target range. Our Wolfspeed business posted quarterly revenue at the top end of the range while our LED business continued to confront a very tough environment partially due to the continued trade and tariff concerns. And while I'm pleased with our execution, the current operating environment is very challenging. Geopolitical and macroeconomic issues impacted our financial results in the fourth quarter, and we expect them to present some additional headwinds in Q1 of 2020 and perhaps beyond. And while there may be some near-term bumpiness, we are more bullish today on the mid- and long-term potential of our silicon carbide and GaN technologies, as customer interests and engagement is as strong as I've ever seen it.

I'll now turn it over to Neill to provide some more color on the financial 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. For the fourth quarter of fiscal 2019, revenue decreased 5% year-over-year to $251 million with non-GAAP net income from continuing operations of $11.5 million or $0.11 per diluted share. The non-GAAP earnings per share from continuing operations exceeded the midpoint of our updated target range due to better-than-expected gross margin in our Wolfspeed business.

Our fourth quarter non-GAAP earnings from continuing operations excludes $46.1 million of expense net of tax or $0.44 per diluted share from noncash stock-based compensation, acquired intangibles amortization, accretion on convertible notes, transaction-related costs, factory optimization restructuring costs and other items outlined in today's earnings release.

2019 fourth quarter revenue and non-GAAP gross profit for our reportable segments were as follows: Wolfspeed quarterly revenue grew 22% year-over-year to $134 million, which was at the high end of our range, but was down 5% sequentially due to the Huawei impact and softness in Power products for industrial and automotive applications. Wolfspeed gross margin was better than our targets at 50.2%, an increase of 150 basis points sequentially.

LED Products revenue was in line with our target at $117 million but declined during the quarter, due to continued global trade uncertainties. LED gross margin was 24.1%, down 370 basis points sequentially primarily due to lower factory utilization. Unallocated costs totaled $7 million for the quarter of fiscal 2019 and are included in our overall cost to reconcile to our $91.9 million non-GAAP gross profit from continuing operations, for a 36.6% total gross margin for the company.

Non-GAAP operating expenses from continuing operations for Q4 were $82 million slightly above our target of $81 million. Our non-GAAP operating income from continuing operations was at the midpoint of our target at $9.9 million. Our non-GAAP tax rate was in line with our targets at 18%.

During the fourth quarter, cash from operations was $3 million and capital expenditures were $37 million resulting in negative free cash flow of $34 million as we continued to invest for growth to expand capacity in our Wolfspeed business. We ended the quarter with $1.05 billion in cash and short-term investments, which includes the proceeds from the sale of our Lighting business, 0 balance on our line of credit and convertible debt with a face value of $575 million. Our capital allocation priorities remain focused on expanding capacity in our Wolfspeed business to fuel future growth.

For fiscal 2019, we reported capital investments of $153 million. For fiscal 2020, we are targeting capital investments of approximately $200 million. For the quarter, day sales outstanding from continuing operations came in at 34 days and inventory days on hand from continuing operations was 104 days.

For fiscal 2019, revenue was $1.1 billion, representing a 17% increase when compared to fiscal 2018. Non-GAAP net income from continuing operations was $76.9 million or $0.74 per diluted share, which was in line with our targets. Non-GAAP earnings exclude $134.8 million of adjustments net of tax or $1.30 per diluted share.

Fiscal 2019 revenue and non-GAAP gross profit for our reportable segments were as follows: Wolfspeed revenue grew 64% year-over-year to $538 million and gross profit was $259 million for a 48% gross margin, which was flat year-over-year due to cost reduction efforts, which were offset by product mix shifts within the business.

LED Products revenue declined 9% year-over-year to $542 million and gross profit was $150 million for a 27.7% gross margin, which is 120 basis points improvement year-over-year. The decrease in revenue was due to softer LED market conditions and trade and tariff concerns with China. The overall margin improvement in fiscal year 2019 was a direct result of higher factory utilization in the first half of the year, cost reductions and continued focus on target markets where we believe our customers value our technology.

Unallocated costs totaled $18 million for fiscal 2019 and are included to reconcile to our $403 million non-GAAP gross profit for a company gross margin of 37.3%, representing a 340 basis point improvement from fiscal 2018.

Turning to the outlook for the first quarter of 2020. We are targeting revenue in a range of $237 million to $243 million based on the following segment trends. Wolfspeed revenue is expected to be down slightly, approximately 5% to 7% due to the full quarter impact of the Huawei ban and softer selling conditions in China as it appears the Chinese governments reduction in incentives is impacting electric vehicle sales.

Regarding Huawei. We are not shipping product at this time, and we will continue to comply with U.S. federal law. We've applied for licenses from the government to potentially resume certain shipments to our customer but have not yet received a response. LED revenue is expected to be down approximately 2% to 4% sequentially due to continued market softness and tariff concerns that Gregg discussed earlier.

We target Cree's Q1 non-GAAP gross margins from continuing operations at approximately 30.8% based on the following segment trends. Wolfspeed gross margin is targeted at approximately 46.3%, down from 50.2% as a result of product mix shifts resulting from the Huawei ban. LED margin is targeted at approximately 17.5%, down from Q4 primarily driven by lower factory utilization and lower sales volume. We are proactively managing the situation and taking a more conservative approach by lowering our factory utilization as well as lowering our inventory levels both internally and in the channel. We believe this will better align us with current market conditions.

We are targeting Q1 non-GAAP operating expenses from continuing operations to be slightly up sequentially at approximately $83 million to support continued growth in our Wolfspeed business. As we have discussed previously, changes in operating expenses 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.

We target Q1 non-GAAP operating loss from continuing operations to be between $12 million to $7 million and we target non-GAAP non-operating income to be approximately $3 million. We are targeting a non-GAAP effective tax rate of 14% for Q1 and Q1 non-GAAP net loss from continuing operations to be between $7 million to $3 million or a loss between $0.07 to $0.03 per diluted share. Our non-GAAP EPS from continuing operations target is lowered by approximately $0.03 due to the ongoing impact of the tariffs.

Our non-GAAP EPS from continuing operations target excludes acquired intangibles amortization, noncash stock-based compensation, accretion on the convertible notes, transaction-related costs, factory optimization restructuring costs 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 Q1 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. I'm pleased to share that we continue making progress on the strategic transformation of Cree as evidenced by the key milestones we achieved during the quarter. We announced plans to expand our silicon carbide and GaN capacity significantly. With the development of a state-of-the-art automated silicon carbide and GaN wafer fabrication facility and a mega factory for materials. We believe this represents the largest capital investment in the history of silicon carbide and GaN technologies and will support the growing demand we expect from automotive, communications infrastructure and industrial segments.

Second, we were selected as the exclusive silicon carbide partner for the Volkswagen Group's Future Automotive Supply tracks initiative or FAST initiative. The goal of the FAST program is to foster even greater collaboration among VW's key partners and accelerate the delivery of new electric vehicles to the marketplace. Volkswagen has committed to launch almost 70 new electric vehicles in the next decade, which by itself presents a great opportunity for Cree.

We announced a multiyear $85 million supply agreement with ON Semiconductor, making this the fourth long-term agreement we have announced in the past 1.5 years. These 4 wafer supply agreements, which now total close to $600 million, demonstrate how our technology is helping to drive the transition in the power semiconductor industry from silicon to silicon carbide.

Lastly, we closed the sale of Cree Lighting to IDEAL Industries, which will allow us to channel more of our energy and expertise into growing our Wolfspeed business. These developments are just a few of the many important steps we've taken in the last several quarters to position the company for long-term growth and to create a semiconductor powerhouse. Recent estimates from Canaccord Genuity are calling for the demand for silicon carbide to grow to more than $20 billion by 2030 mainly driven by a major expansion in electric vehicles and the need for charging stations. These vehicles, along with a host of wireless broadband dependent devices, will be connected to ultrafast 5G networks that can transfer massive amounts of data and support levels of interconnectivity that have never been possible before.

At the core, helping to power these solutions will be silicon carbide and GaN, technologies that we have pioneered over the last 30 years and we continue to refine each and every day. Our robust pipeline of opportunities reinforces our confidence in Cree's long-term growth prospects. Over the last few months, I've met with some of our top customers and prospects, and they continue to tell me how our silicon carbide and GaN solutions are key to their future growth plans. Our leadership position in the space is helping to build the opportunity pipeline, which now stands at more than $9 billion. This covers automotive, solar, telecommunications, industrial and mil-aero sectors.

In closing, there's a significant opportunity to help customers make the shift from silicon to silicon carbide and GaN solutions for their next-generation applications.

With that, I'll turn it back to the operator to start the Q&A session.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first 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 [2]

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Gregg, the first thing I wanted to ask about is the outlook for repeat orders on the wafer side. When we do some of the back-of-the-envelope math, the STMicro order several months back, $250 million. That looks like it could be close to half of what their needs are over the next 4, 5 years. And if we look at your more recent order from ON Semi, it looks like it could be somewhere closer to 1/4 to 1/5 of their total needs over the next give or take 5 years. What do you think we need to see to have these customers come back and place additional orders? Or how would you describe the potential for additional wafer orders from existing large power semiconductor companies that are well known to the investment community?

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

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Well, thanks a lot, Craig, for the question. And I would say a couple of different things. One is we've announced 4 of these long-term supply agreements. We have a number of other supply agreements that we've inked as well that don't have the same kind of length of time, so we've chosen not to announce them.

What I would say is we're in discussions with a number of other companies as well around these long-term agreements. And recall the long-term agreements give our customers in this regard a couple of really key advantages. One is access to capacity and a guarantee of capacity, and the second is access to a pretty decent cost reduction curve that we are driving internally. And on the flip side of it, we get a couple of really key things as well. One is a guaranteed demand that has pretty significant teeth in it and then a relatively sizable upfront payment that is associated with us helping to build out that capacity.

I would say the interest in continuing those dialogues remains very, very strong. I think our customers are beginning to see more and more of their customers express interest and excitement around silicon carbide. I think especially in the electric vehicle, I think we passed the tipping point of the value -- the incremental cost of using silicon carbide being way surpassed by the value that you get. So I think you'll see continued work with us in this regard, and I think we'll continue seeing these types of deals being worked and announced.

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Craig Edward Irwin, Roth Capital Partners, LLC, Research Division - MD & Senior Research Analyst [4]

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Great. My second question is about the device updates. Can you maybe share with us where you stand on the update cycle for both silicon carbide and GaN? What we can look for as far as potential product portfolio adjustments over the next handful of quarters?

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

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Sure, Craig. What I will tell you, I mentioned in the prepared remarks that we've got $9 billion pipeline, and just to be very clear about that, that's a $9 billion device pipeline. So it's a sizable pipeline for our device business. And these are dozens of different opportunities -- probably multiple dozens of opportunities that are in various different phases of gestation. Some are in a relatively early phase. But I would also say that some are in quite late innings in terms of decision time. I think over the next 12 months, maybe plus or minus a few, you've got to see a lot of decisions that are coming down, and that's primarily because these decisions have to be made because the car platforms and base station platforms are going to be ramping in times where their customers have to make these decisions. I feel really good about where we're at on that front. And like I said, we've got a variety of different customers in a number of different stages, some of them as I said in quite the late innings.

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Operator [6]

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And 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 [7]

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I had 2. I guess first on Wolfspeed. Neill, if you exclude the Huawei impact, could you help us with how to think about Wolfspeed's revenue outlook, what that would have been here sequentially? What the organic growth rate that would have implied year-on-year? And then what's the visibility, I guess, Gregg, you have on China EVs and when the subsidy timing out there is behind you in terms of being a headwind? I know this is probably the second quarter here you've called this out, so just trying to get a sense for how much visibility you have there on the near-term from that kind of subsiding.

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Neill P. Reynolds, Cree, Inc. - CFO [8]

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Brian, so let me try and give you an idea of how we're thinking about the Huawei impact on the top line. So if you recall, we provided the updated outlook on June 11. We said we have stopped shipping to Huawei. And the revenue from product and materials associated with their build-out was about $15 million per quarter, and that's what we would have expected in Q4. We've already shipped some product prior to the ban, but most of the shipments didn't happen. And that would represent kind of a revenue number in the quarter, say, $10 million impact, okay?

As you look forward, the impact of the ban was kind of hard to predict. We sold to Huawei, which we're no longer doing, through 3 channels, essentially, direct, through RF component suppliers as well as through our materials business. So the latter 2 channels, I guess, along with the overall Huawei supply chain is still kind of adjusting to the ban. So I'd say in addition, Huawei is still looking for alternate supply options. So you put all that together and it's kind of difficult to say how much revenue will be pointed to us if the ban was lifted. The supply chain will need to adjust again, and of course, that would take time to play out. It's been kind of 3 months into the ban and things are shifting.

In a steady state, I'd stay still kind of about $15 million a quarter, but given some of those supply chain dynamics that I just kind of talked about, it's hard to predict what will happen. So in the meantime, we don't plan on shipping to Huawei unless something else changes with the U.S. government on this one, but in terms of the go forward, so it's kind of hard to say exactly what that would be.

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Gregg A. Lowe, Cree, Inc. - President, CEO & Director [9]

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And then on China EV, we're in the early phase of the implementation of the reduction in subsidies. And I've talked to a number of different OEMs in China about this, and I think they're trying to anticipate what's going to happen with consumer demand. They don't know exactly what's going to happen. So I would say it's kind of a short-term or near-term kind of prioritization, if you will, and trying to adjust to what those new subsidies are going to do.

What I would tell you is the remaining subsidies are on vehicles that have longer range. Longer-range cars tend to have bigger batteries and more powerful inverters, which tends to increase the potential for silicon carbide. So longer-term, it could be a benefit for us.

And then finally, I would say I think China in general continues to really try to drive their auto industry in the direction of EVs. So I think that's going to be something that once we get through this kind of short-term how do you adjust to the ban, it probably continues kind of a positive momentum.

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Brian K. Lee, Goldman Sachs Group Inc., Research Division - VP & Senior Clean Energy Analyst [10]

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Okay. Fair enough. And just a second question, if I could squeeze it in, on the LED segment here. I know given the recent challenges, it sounds like maybe the strategic thought process on that business is you're open to considering more alternatives. Anything you can maybe outline at a high level on how you're thinking about the LED segment and if you're thinking about other options to turn it around here or if there are maybe other strategic alternatives that are entering into the picture.

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Gregg A. Lowe, Cree, Inc. - President, CEO & Director [11]

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Yes, I'll take that, Brian. So thanks for that question. What I would tell you is when we redefined the strategy of the company, we said we're going to focus the LED market in areas where we're going to get better value for the technology that we drive, and we're doing that right now. We've got some good traction right now in the automotive space in high-bright and so forth.

The overall industry is down, and what we said we were going to do is to the extent that there was going to be an impact, a negative impact on the LED business, we were going to transition the fungible capacity of LED over to Wolfspeed. And just recall that capacity is in 2 kinds of buckets. It's silicon carbide materials, where the fungibility is 100% and the transition of that material from -- capacity from creating something for a LED and creating something for Wolfspeed, that transition is a matter of a week or 2. So we've already done that. We're already doing that transition as the LED market slows down.

And then the second issue is or the second amount of fungibility is in wafer fabrication, and we've got -- we're taking loadings down pretty significantly. That is the major impact of the LED gross margin. And so wafer fab utilization coming down and we are also in the process of transitioning that capacity over to Wolfspeed as well. Now that transition takes a lot longer. That's more of a 9 to 12 to maybe 15 months kind of time frame. So in the meantime, we're going to have some underutilization.

But I think as we come out of this and we see the ability to move LED to more of a fab light type process, where we outsource whatever we can on that, I think we'll see -- and we transition that internal capacity over to Wolfspeed, I think we'll see a benefit from that.

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Operator [12]

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And our next question comes from Jed Dorsheimer with Canaccord Genuity. And 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 [13]

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Gregg, so listening to a couple of the other earnings call, I mean, the setup appears to be from the big guys that supply to automotive is that things like radar, ADAS, silicon carbide, charging, things of that nature are still reasonably strong. Do you think it's end demand in China due to subsidies or do you think it's just gestation or maybe inventory that was built up?

And then in the same sort of vein, if the trade situation doesn't change, is this a steady base of revenues that we should think about for Wolfspeed?

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Gregg A. Lowe, Cree, Inc. - President, CEO & Director [14]

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Yes. So what I would say is a couple of things. First off, from my discussions with China OEMs, there's a sentiment that the consumers were aware of the eventual decline of some of the subsidies, so there was perhaps some buying of electric vehicles that was kind of pulled in, if you will. And I think they're really just trying to absorb what does it mean more long term. So I think that's the understanding that I'm getting from the Chinese OEMs on that. And I guess, it kind of makes sense to me from that perspective.

From a silicon carbide demand in automotive, I think that remains very, very strong in general, and I think what's going to happen over the coming decade to be or just be really long term is you're going to see car companies introduce new platforms to the market. Those platforms will take off at certain speeds. They will plateau, and then a new car platform will come on. So as an example, all 70 Volkswagen car platforms aren't going to come to the market at the same time. They'll release some. Those products will get into the market. They will achieve a certain amount of volume and then probably hit a steady state. They'll release new market -- new cars. Those products will ramp and so forth. So you'll see a series of increasing demand followed by maybe some amount of plateau, followed by increasing demand and new entrants and so forth. And I think we're going to see that across multiple different car companies over the coming decades.

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Harsh V. Kumar, Piper Jaffray Companies, Research Division - MD & Senior Research Analyst [15]

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Got it. And another one for my second one. I know you don't like to break out materials versus your chips business but I was curious if you would -- you wouldn't mind giving us some color on RF, just without numbers qualitatively, RF versus the automotive business, the Power industrial business. Any kind of color on what they may be as a part of Wolfspeed?

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Gregg A. Lowe, Cree, Inc. - President, CEO & Director [16]

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Yes. Maybe just a couple of different vectors on that. So first off, the opportunity in Power is really fueled by a lot of different things, but primarily the biggest growth engine is going to be the electrification of the powertrain of a car. And we've seen reports from anywhere from 6 billion to 20 billion that I talked about by 2030 in terms of what that market size is for just the electric car platform and silicon carbide, and that would be the Power business.

Whereas the market for RF is primarily -- the growth is primarily going to be driven by 5G, which most people estimate to be a couple of billion dollar type opportunity. So over the longer period of time, Power is going to be a bigger opportunity, I think, in silicon carbide versus silicon carbide on GaN. So both nice growth opportunities but Power probably the bigger upside.

Underpinning all of that is the materials, and so that's from the device perspective. From a materials perspective, we sell both into the Power and into the RF space, as Neill mentioned earlier, and what I would say is we believe that our device -- our 2 device businesses and our materials business will all be growing over the time period of our long-range plan, which is over the next 5 years or so. But certainly, over the more near-term aspect of that, we're likely going to see the growth in materials being faster, and that's simply because our materials customers channel to market is sizeably bigger than ours. A lot more feet-on-the-street in terms of selling assets, applications, engineers, designers and so forth just with the 4 supply agreements that we have.

So I think it's a conversion of the industry from silicon to silicon carbide. We're excited about that. We're excited about the partnership we have with the 4 companies that we've announced long-term agreements with, and I think we'll all see really nice growth in the coming decade.

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Operator [17]

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And our next question comes from Jed Dorsheimer with Canaccord Genuity.

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Jonathan Edward Dorsheimer, Canaccord Genuity Corp., Research Division - MD & Analyst [18]

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So I guess, real quick, my first question is on -- is actually on LED business, and how much of that auditing process into the auto supply chain are you able to pull over to Wolfspeed particularly on the device side? Because that would be one of the greatest challenges between wafer supply and moving this model from sort of an (inaudible) light to more of the STMicro model and the leverage associated with that. So I was wondering if you could just address that, Gregg.

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

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Jed, it's Neill. So I think you said on the device side -- you dropped there a bit. Was that what you had said?

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Jonathan Edward Dorsheimer, Canaccord Genuity Corp., Research Division - MD & Analyst [20]

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Yes. So specifically the auditing process for auto is much more intense and robust. And I'm wondering on the LED business, how much of the learning curve were you able to benefit from to accelerate that for the Wolfspeed device side of the business?

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Neill P. Reynolds, Cree, Inc. - CFO [21]

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Yes. So a couple of things on that. So as you think about -- let me talk about the LED business first and kind of our plans there and I'll relate it back to kind of Wolfspeed here in a second. When we talk about the capacity expansion originally, what we have said is that, and Gregg kind of alluded to it, that we would outsource pieces of the LED business and that would free up capacity for Wolfspeed. And as we outsource some of those pieces, we'll have more opportunity in the wafer fab.

Now 2 things there. One is that you kind of mentioned the automotive kind of side of it. Certainly, there are learnings there, but as we free up the capacity, remember the capacity expansion kind of has 2 pieces on the device side. One is we're going to convert the current factory we've got. And the second one is once we announced the capacity expansion, we're going to build out the North fab, and in that we will have more of the -- building up more of that kind of quality -- automotive quality capability as we're moving forward, and we're investing in that. So as we move through the capacity expansion, sure we'll lever the pieces from the LED business and learnings we have, but we're going to set up the fab as we move forward and build it out to have that quality capability.

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Gregg A. Lowe, Cree, Inc. - President, CEO & Director [22]

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And then the second thing that I would add to that, Jed, is we've also been very, very successful bringing in automotive experienced people into some very, very key positions. So as an example, we're talking about building a new fab. The person that's going to run that fab has over 20-plus years of semiconductor, manufacturing experience at a world-class, highly-regarded automotive semiconductor company and also spent a number of years at a automotive Tier 1 supplier. The head of our quality organization joined us about a year ago or so, and she has as well, over 2 decades of automotive quality experience working for a large world-class semiconductor company focused on automotive. And I can name a number of other folks that have kind of come into the organization that bring very specific knowledge of automotive requirements. And we think this is going to be a really great benefit to augment the 30-plus years of experience that we have internally at Cree on silicon carbide and gallium nitride.

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Jonathan Edward Dorsheimer, Canaccord Genuity Corp., Research Division - MD & Analyst [23]

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Got it. And just as a follow-up -- and the first question I was trying to ask was, you spent the value proposition on the auto side -- on the vehicle side. It's certainly more compelling than that of the charging or the infrastructure side. But just as we heard from at our conference last week, from National Grid that there seems to be a compelling story around the infrastructure build-out, and also the use of silicon carbide associated with that, particularly around fast charge. So I was wondering if you might be able to update and articulate sort of what the plans are on the infrastructure side and how you see that opportunity as well?

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

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Well, we see it as a great opportunity, Jed, and that's part of that $9 billion pipeline that we've been talking about. We've got a number of different customers that are associated with charging in the grid and rapid charging and so forth. And as you properly point out, rapid charging is going to be a really important aspect to the build-out of the electrification of the powertrain. And we've got customers that are developing technologies to add significant amount of mileage capability in sort of 5 minutes type time frame. And to do that, you need high-voltage. And silicon carbide, the higher the voltage, the better it is for silicon carbide, so we think that this trend of higher bus voltages inside the inverter, the more rapid charging and higher voltages associated with rapid charging is just going to continue to help fuel the demand for silicon carbide. So we're pretty excited about that as well.

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Operator [25]

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And 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 & Applied and Emerging Technologies [26]

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Just a quick one really, Gregg. I just want to check if there's sort of take or pay or other sort of time-based elements to the large contracts that you have with the sort of temporary slump in demand. You sort of forfeit some of the economics of those deals or the customer has to pay up regardless of their consumption?

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Gregg A. Lowe, Cree, Inc. - President, CEO & Director [27]

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Yes. The deals generally have that kind of element associated with it. I won't get into a lot of details, but they have pretty strong commitment to take a volume that was committed. Now there are some upside capability on that and there are some downside and it's sort of symmetric, if you will. And so these deals are really meant to kind of guarantee that we would be able to supply a certain capacity to our customers and guarantee that they would supply a demand to us. So we're both kind of equally committed into that, and it does have that kind of element, Paul.

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Paul Coster, JP Morgan Chase & Co, Research Division - Senior Analyst, Alternative Energy & Applied and Emerging Technologies [28]

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All right. So the obvious follow-on question is, is there any risk at all if there are some inventory building up in that channel?

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

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I don't see it right now. I would say in every supply/demand mismatch kind of situation, there's always a risk to that. But even our business today, our silicon carbide epi capability is capacity-constrained. Our Power capability, especially in 150 millimeters, capacity-constrained. And even despite the situation with Huawei, our RF line is capacity-constrained. So we remain with pockets of constraint.

And I think as we expand the capacity we'll see areas that see the constrain go away and other areas that will pop up. And then if those areas where the capacity-constrained goes away, we're going to see customers ramp up their next-generation thing and it will come back. So I think we're going to have at the very least through the next 5 years as we continue ramping this capability, we're going to have sort of a leapfrogging of the demand and supply over the next 5 years, where we catch up and then it all of a sudden takes off again and we're behind.

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Operator [30]

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And 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 [31]

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Just regarding CapEx, I mean, how should we think about the cadence of that? And the contractual trigger for you guys in terms of if a customer slows down in terms of some of the purchasing given some of the twists and turns that we're seeing on the EV side, is there a point at which you guys would slow things down or speed things up? And how should we think about the triggers on that?

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Neill P. Reynolds, Cree, Inc. - CFO [32]

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Yes. So first of all, let me say, so overall for -- I guess I said it in the prepared remarks. When I do -- we're going to spend roughly $200 million in CapEx in 2020. As it relates to those things, yes, I mean, we can always move things around, but our view is a longer-term opportunity in the silicon carbide space such that we're going to continue forward with that. There's always opportunity to modulate as things go on, but I would think about that as kind of longer-term modulations. In the near term, we're going to continue with the investment in the Wolfspeed business and continue to extend the capacity expansion and continue to manage through that. Our view is we really need to focus on that right now to be ready for the opportunity.

And so as it relates to the modulation, yes. I think if you take a look at our materials business, it's something that we could obviously manage a little bit easier as you add capacity grower by grower. In the fab, that's a little bit harder as you add it kind of line-by-line and we would manage that again over the long term. But right, now our view is we're going to invest in the capacity expansion of Wolfspeed.

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Colin William Rusch, Oppenheimer & Co. Inc., Research Division - MD and Senior Analyst [33]

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Okay. And then just in terms of kind of where you're targeting designs. Obviously, the Tesla onboard charger for the Model 3 is important and kind of validates in terms of some of those high-voltage charging. But as we target some of the other applications that's in the powertrain, can you talk a little bit about how you break out that pipeline of opportunity and the competitive dynamics around each of those opportunities?

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

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Well, basically, as customers start looking at their products, we're seeing a couple of different trends. One is moving towards higher bus voltages, which enables them to take really stronger advantage of silicon carbide. And the silicon carbide basically, then enables the car manufacturers to have a smaller battery and the battery is the most expensive part to an electric vehicle. So I think it's a really pretty straightforward equation.

And we're in conversations with dozens of different car companies around the world right now, and of course, be associated with OEMs and inverter manufacturers. And I think the debate of whether silicon carbide is going to play a role or not, I think that I feel pretty comfortable that, that debate is now over and it's very, very clear that silicon carbide is going to play a role. And I think it's going to be a pretty significant role.

So we're working with all of our customers on that. We've got, as I mentioned, we've got dozens of different design opportunities that we're working in our design in pipeline. Some of them are in more early phases. Some of them are in the late innings. And so we're hoping to get a couple of those across the goal line as soon as possible. And I really think over the next, as I mentioned, 12 to plus or minus 6 months type of time frame, we're going to see -- a lot of those decisions are going to have to come down because the car platform is going to launch in a certain time frame and they're going to have to make those decisions.

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Operator [35]

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And our next question comes from Jeff Osborne with Cowen and Company.

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Jeffrey David Osborne, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [36]

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A couple of questions on my end. You guys did a wonderful job in explaining kind of the long-term value and where things are headed, and seeing the $9 billion pipeline is terrific to see. I think it's $5 billion last quarter, but I was wondering if you could help us better understand what the complexion of Wolfspeed is today in particular with the guidance being down about 400 basis points in margins with the -- I think you highlighted mix being an issue there. I don't know. Can you -- if you don't want to get specific, at least rank order between RF, Power and materials what the biggest pieces are and then what the margin differentials are broadly between the 3?

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Neill P. Reynolds, Cree, Inc. - CFO [37]

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Yes, let me -- this is Neill. Let me take a shot on that. The predominant driver of the changes in the Wolfspeed gross margin are related to the Huawei ban. So in 4Q, we saw an increase of 150 basis points. So when the Huawei ban went into effect, we stopped shipping in our lower-margin products and that was really the main driver of the kind of 150 basis point improvement and getting the Wolfspeed gross margin in 4Q up over 50%.

As you swing back to 1Q, we're seeing kind of the opposite effect. And the margin is moving down almost 400 basis points. So customers in our kind of RF component and materials channels are kind of reacting to that, as I said earlier, in different ways. Either you're not shipping or looking for alternative customers.

So as these 2 channels kind of adjust to the ban, we're seeing a lot of variability in the mix and kind of new order patterns are developing. So think about the overall supply chain is just starting to kind of settle in and understand how to kind of react to the Huawei situation.

I will say we see this kind of variability in the mix as kind of a temporary phenomenon. It really does not change our view on the Wolfspeed kind of gross margin, as we talked about before, getting to the low to mid-50% type level. Our costs and our gross margin programs are on track. And then in the meantime, we'll just deal with the variability in the mix as customers continue to adjust to the ban. Just kind of causing some of that short-term variability.

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Jeffrey David Osborne, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [38]

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Got it. And then my second question was just a follow-up on the auto qualification process, and auto experience of the company as a whole, which you touched on before. Certainly, you highlighted the 30-plus years of experience in making SiC and a bunch of new people, the head of the fab, which sounds great. But I was just curious if you're quoting business today in that 9 billion pipeline, do you need one of these auto grade fabs to be up and running to win the business today or having the right staff and sort of the historical expertise, is that enough? I just wasn't sure if there's a gap of time and unfortunately you can't hit the window and maybe more of the wins would fall in your pocket in 2020, 2021 as these fabs open up?

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

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No. I think the decisions that are being made today for the automotive -- the automotive-related decisions that are being made today are for cars that are going to go into production in sort of 2022 through 2024 type time frame. That would be kind of the normal gestation period, if you will, for design win pipelines that are in discussions right now. And recall that we intend to open up our new factory in 2022. So the timing of that actually fits pretty nicely with that. I'd be -- it would -- obviously, if that factory were open today, it would be nicer, but I think there's no issue with the timing of that opening up in 2022. I don't see that as an impediment to us engaging with customers on these design wins.

The real question is around our ability to sustain the manufacturing capacity. And that has been the major question that I've had in the 1.5 year or almost 2 years that I've been here. And I think this capacity expansion of increasing our capacity by 30x compared to where we were when we initially began the capacity ramp in fiscal '17 has basically, answered that bell, and I think our customers see that. They see that as a real commitment, and they know that if they agree to move this certain car platform or this inverter platform from some kind of silicon-based system to a silicon carbide-based system, we're putting real money behind the capacity that will allow them to feel good that, that capacity is going to be there as they ramp their products and customers get excited about their products.

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Operator [40]

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And our next question comes from Joseph Osha with JMP Securities.

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Joseph Amil Osha, JMP Securities LLC, Research Division - MD & Senior Research Analyst [41]

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I apologize for the bad audio. I'm in a car. It seems like all of the questions on the Chinese market sort of have this return to the status quo ante built into them. I guess, I'd like to turn that question on its head and ask you, what happens if this disengagement from China is much broader and a year from now you're not selling anything to any Chinese automotive OEMs or communications OEMs maybe ever again?

And I guess, the flip side of that also would be competitively understanding, of course, that you're not seeing much now, how would you feel if you could say, oh, gosh, we don't really think we're ever going to face any competitive pressure from a heavily subsidized Huawei effort in silicon carbide or whoever because they're not selling to any of our customers either? I'm trying to understand broadly if Cree and the Chinese market completely disengaged, what your business looks like.

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Gregg A. Lowe, Cree, Inc. - President, CEO & Director [42]

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Joe, I think that's a great question and it's one that we certainly are addressing internally as well. And what I would say is, any semiconductor company has to ask that same question because a substantial portion of the semiconductor market is in China and a substantial percentage of the growth is there as well. So obviously, I think nobody would be fair to say, well, it wouldn't matter if we just -- China never came back. Of course, it would matter. It's a big percentage of the semiconductor market and a growing percentage of it. So it certainly would have an impact. I think there's no question about that.

What I would say from a competitive position standpoint is there's really -- this technology, as we've mentioned several times, is a difficult technology to replicate. It's a technology that has industry know-how requirements and the industry know-how is measured in hundreds of people versus tens of thousands of people. So it's -- while we worry every single day about competitors from all different walks of life, whether they're international competitors or U.S.-based competitors, we worry about them and the best thing that we can do is just run as quickly as we can to increase our -- the quality of our product, decrease the cost of our product and increase the scale and the capacity that we have. So that's what we attack on a daily basis.

From an automotive perspective, specifically, I'd say we've got a ton of interest across the globe, including a ton of interest outside of China in the silicon carbide. And I think there's a tremendous amount of growth opportunity for us there. We'd like to have the entire world TAM as part of what we're going after. So we're very hopeful that the world's 2 largest trading economies will figure out a good solution. But I think we've got a lot of opportunity outside of that as well.

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Joseph Amil Osha, JMP Securities LLC, Research Division - MD & Senior Research Analyst [43]

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Okay. And just as a follow-on, would you care to maybe talk about China exposure inside that $9 billion pipeline that you discussed?

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

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I don't have that broken out. Just from a gut feel perspective, I'd say it's not as high as you would anticipate, but let's just do a follow-up on that. But what I can clearly say, it's not like half or some dramatic portion of it. We've got a lot of opportunity over there, but we've got a substantial amount of opportunity outside that. But Joe, I don't have that number specifically, but I'm pretty comfortable saying it's going to be well less than half.

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Operator [45]

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And our next question comes from Ambrish Srivastava with BMO.

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Jamison Yeol Phillips-Crone, BMO Capital Markets Equity Research - Associate [46]

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This is Jamison calling in for Ambrish. So in your prepared remarks, you guys have mentioned the lowering factory utilization as well as reducing inventory in the channel as well as your own. It looks like in the quarter, it ticked up a little bit. But I guess, my question is as it relates to gross margin and assuming demand remains somewhat muted, what is your target for inventory days? And I guess, how long do you think it will take there -- or take to get there before you feel comfortable ramping up utilization? And I guess, as well, do you expect gross margin to remain depressed through then or do you think it could return to maybe a mid-30s to high-30s run rate?

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Neill P. Reynolds, Cree, Inc. - CFO [47]

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Yes, so let me -- I think if you look at both the inventory and the gross margin, it's important to unpack that a little bit because the Wolfspeed business and the LED business have very different dynamics. On the LED side, obviously, the market situation that's been impacted by China and the tariffs has muted the business from a top line standpoint, as you suggest.

So what we're doing is we're taking a conservative approach there, and we're taking down, as you talked about, our utilization, we're taking down our inventory to kind of go manage that. And I think that's going to set us up for any kind of medium term either demand declines and kind of position us in the event favorably should upside happen.

Our view outside of this quarter on LED, it's difficult to call. We kind of just think at this point we don't see any kind of recovery in the near term and we're kind of managing ourselves in a way to kind of handle that.

On the Wolfspeed side, it's not really utilization impact. On the Wolfspeed side, we have a little bit of elevated inventory. Obviously, with a little bit of the effect of the Huawei ban, we're carrying some additional inventory. We're also matching up supply and demand in different areas in the business. Gregg kind of talked about some of those pockets earlier. As those thing start to kind of resolve themselves and we get to growth again in Wolfspeed, we expect to burn that off. Our goal would be to get down closer to 90 days so the current days inventory we have on hand, it's not something where we want to be, but I think we've got a handle in both businesses on how to manage that going forward.

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Operator [48]

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And our next question comes from Sidney Ho with Deutsche Bank.

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Shek Ming Ho, Deutsche Bank AG, Research Division - Director & Senior Analyst [49]

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My first one is there have been some concerns that Huawei has been building a lot of inventory prior to the ban taking effect, especially on the infrastructure side. First, do you have any visibility about that? And two, do you have any mechanism in place to monitor that? In other words, even when you get the license approved, do you think you can get back to that $15 million run rate pretty quickly?

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Neill P. Reynolds, Cree, Inc. - CFO [50]

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Yes. So on the Huawei side, I think the way to think about that one is -- and I kind of mentioned it earlier. We sell to Huawei through a number of channels. I would say as it relates to -- I mean to step back, as part of the ban, we have limited interaction with them at this point, so it's really hard for us to say whether or not they're building inventory or not or in terms of how they're managing it. What we are seeing, though, is in the channels that we are selling through, there's certainly some changes and some variability in the order and the mix and the patterns. So as that starts to kind of play its way out, that's going to change what we're kind of seeing in the Wolfspeed business.

As we move forward, let's say the ban was lifted, I think it could take some time before that snapback. So the supply chain will have to readjust again. And certainly, Huawei is very likely looking for alternative suppliers. It would be difficult to say how much of that will be pointed to us if the ban is lifted, so the visibility in terms of what that would mean to us is kind of difficult to call at this time.

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Shek Ming Ho, Deutsche Bank AG, Research Division - Director & Senior Analyst [51]

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Okay. Great. My follow-up is on a shorter-term question on the China EV side. Clearly, there has been a near-term headwind, but 2 questions here. One is, how should we think about the lead time of your wafer or device sales relative to the final sales of the vehicle? And secondly, I'm also curious why the slowdown -- the subsidy cuts have a meaningful negative impact on Wolfspeed. Given the adoption of silicon carbide in China, it's probably quite limited even for longer-range vehicles.

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Gregg A. Lowe, Cree, Inc. - President, CEO & Director [52]

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I guess, I'll take a crack at that. And I don't know exactly how to answer it. Well, I guess, what I would say is, from a lead time perspective, I think there's been a couple of things that have been happening. I think the OEMs are trying to figure out what the consumer response is going to be to the lowering of the tariffs. And so they've been cautious in terms of building up inventories and so forth.

They're also trying to figure out how much of their previous several quarters of demand on electric vehicles was pulling ahead from the consumers attempting to get cars with those incentives baked in. So I think -- I would say it's a time of trying to figure it out and adjust from an OEM perspective. And then from a silicon carbide in cars, we do sell silicon carbide technology to Chinese auto manufacturers, a number of different of their applications, and we see it obviously, as a good potential in the future as well.

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Operator [53]

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Ladies and gentlemen, this concludes our question-and-answer session. I would now like to turn the call back over to Gregg Lowe for any closing remarks.

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Gregg A. Lowe, Cree, Inc. - President, CEO & Director [54]

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Well, thanks a lot, operator, and thanks, everybody, for your interest in Cree. And while we continue to address the softness in the LED sector and the macroeconomic and geopolitical issues in the short term, we remain very bullish on the mid- and long-term outlook for our business. Our opportunity pipeline is very robust, and we believe that our silicon carbide and GaN technologies offer competitive advantages versus traditional silicon. We look forward to speaking to you at the end of October for our fiscal first quarter 2020 results call, and hope to see you at our Investor Day in New York on Wednesday, November 20, at the Grand Hyatt Hotel. Thank you, all, and have a nice day.

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Operator [55]

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Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program and you may all disconnect. Everyone, have a wonderful day.