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Edited Transcript of CREE earnings conference call or presentation 1-May-19 9:00pm GMT

Q3 2019 Cree Inc Earnings Call

Durham May 3, 2019 (Thomson StreetEvents) -- Edited Transcript of Cree Inc earnings conference call or presentation Wednesday, May 1, 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 Gronbach

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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

* Jonathan Edward Dorsheimer

Canaccord Genuity Limited, Research Division - MD & Analyst

* Joseph Amil Osha

JMP Securities LLC, Research Division - MD & Senior Research 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 the Cree Inc. Third Quarter Fiscal Year 2019 Earnings Conference Call and Webcast. (Operator Instructions) As a reminder, today's program is being recorded.

And now I'd like to introduce your host for today's program Tyler Gronbach, Vice President of Investor Relations for Cree. Please go ahead, sir.

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Tyler Gronbach, [2]

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Thank you, operator, and good afternoon, everyone. Welcome to Cree's Third Quarter Fiscal 2019 Conference Call. Today Gregg Lowe, our CEO; and Neill Reynolds, our CFO, will report on the results for the third 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 corresponding GAAP measures is in our press release and posted in 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 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. I'd like to welcome Tyler to the Cree team. He joined us a few weeks ago to serve as our VP of Investor Relations and we're delighted to have him on board.

For today's call, I'll briefly discuss our financial results, after which Neill will provide more color regarding Q3 and our Q4 outlook. After that, I'll provide an update on how each business is performing along with some highlights for the quarter.

We delivered solid results in Q3 with non-GAAP earnings per share that exceeded the midpoint of our target range that was provided back on March 15. Once again, the results were driven by record sales and margin improvement in our Wolfspeed business and solid performance in our LED business.

In Q3, we took an important step in the transformation of the company with the pending sale of Cree Lighting to IDEAL Industries. This transaction will allow us to sharpen our focus to accelerate Wolfspeed's growth while providing a terrific opportunity for the Lighting business and its employees to an expanded channel that strengthens its market position. We believe this transaction benefits all stakeholders as it unlocks value, increases management focus on the core business and supports our mission to accelerate silicon carbide and GaN adoption.

I'll now turn it over to Neill to provide more details on the 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. For the third quarter of fiscal 2019, revenue from continuing operations increased 22% year-over-year to $274 million, with non-GAAP net income from continuing operations of $20 million or $0.20 per diluted share. The non-GAAP earnings per share from continuing operations exceeded the midpoint of our targeted range, due to record revenue combined with margin improvement for Wolfspeed. Our non-GAAP earnings from continuing operations exclude $43 million of expense, net of tax, or $0.42 per diluted share from non-GAAP stock-based compensation, acquired intangible amortization, interest accretion on the convertible notes, transaction-related costs and other items.

2019 third quarter revenue and non-GAAP gross profit for our reportable segments were as follows: Wolfspeed revenue grew 72% year-over-year and 4% sequentially to $141 million, at the high end of our targets. Wolfspeed gross margin was better than our targets at 48.7%, an increase of 90 basis points sequentially. LED Products revenue was in line with our targets at $133 million. LED gross margin was 80 basis points above our targets at 27.8%. Non-allocated costs totaled $2 million for the third quarter of fiscal 2019 and are included to reconcile to our $104 million non-GAAP gross margin profit from continuing operations for a 37.9% gross margin.

Non-GAAP operating expenses from continuing operations for Q3 were $80 million, slightly better than our target. Our non-GAAP operating income from continuing operations exceeded the midpoint of our targets at $24 million. Our non-GAAP tax rate was in line with our targets at 18%.

During the third quarter, cash from operations was $61 million and capital expenditures were $37 million, resulting in free cash flow of $24 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 $789 million in cash and short-term investments, 0 borrowed 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.

For fiscal 2019, we target capital investment of approximately $175 million, primarily driven by expanding Wolfspeed's production capacity to support forecasted long-term customer demand. The underlying investment plan for fiscal 2019 remains unchanged, but the investment below -- the investment is below our prior target, primarily due to the timing of receipts and payments for equipment orders. As we continue to ramp this new capacity, we expect some variability in our initial production yields and factory utilization that may reduce our near-term Wolfspeed gross margins.

For the quarter, day sales outstanding from continuing operations came in at 34 days, and inventory days on hand from continuing operations was 90 days.

Turning to the outlook for Q4. We are targeting revenue from continuing operations in a range of $263 million to $271 million based on the following segment trends: Wolfspeed revenue is expected to increase approximately 1% due to strong materials and RF demand. Our Power device business, we are seeing some near-term softness due to the uncertainty around the reduction in EV incentives in China. But we remain confident in the EV market and will continue to grow over the long term. LED revenue is expected to be down approximately 5% sequentially due to market softness, primarily in Asia.

We target Cree's Q4 non-GAAP gross margins from continuing operations at approximately 37% based on the following segment trends: Wolfspeed margin is targeted at approximately 49%, an incremental increase year-over-year and sequentially; and LED margin is targeted at approximately 25%, down from Q3, primarily driven by lower factory utilization and lower sales volume.

We are targeting Q4 non-GAAP operating expenses from continuing operations to be slightly up sequentially at approximately $81 million to support continued growth in our Wolfspeed business. As we have discussed previously, 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. We target Q4 non-GAAP operating income from continuing operations to be between $14 million to $19 million, and we target non-GAAP nonoperating income to be approximately $2 million.

We are targeting a non-GAAP effective tax rate of 18% for Q4 and fiscal 2019 and Q4 non-GAAP net income from continuing operations to be between $12 million to $17 million or $0.12 to $0.16 per diluted share. Our non-GAAP EPS from continuing operations target already includes a decrease of approximately $0.02 from the ongoing impact of the tariffs.

Our non-GAAP EPS from continuing operations target excludes acquired intangible amortization, noncash stock-based compensation, interest accretion on our convertible notes, transaction-related 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 Q4 targets are based on several factors that could vary including overall demand, product mix, factory execution and the competitive environment.

I'll 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. Over the last 18 months or so, we've made great progress towards our goal of creating a semiconductor powerhouse in silicon carbide and GaN technologies. We've grown Wolfspeed by more than 100%; acquired the Infineon RF Power business; more than doubled our manufacturing capacity of silicon carbide materials; jointly announced with Valeo an innovative forward lighting solution for the automotive industry; and signed multiple long-term silicon carbide materials agreements, which in aggregate should generate revenues in excess of $500 million.

With the anticipated completion of the Lighting divestiture during this quarter, Cree will be well positioned for faster growth and higher margins with a cash balance approaching $1 billion upon closing. I'd like to thank the Cree Lighting employees for their hard work and dedication towards fixing the business, which translated into an opportunity for them to become a big and important part of IDEAL Industries.

For LED Products, another quarter of solid execution helped the business make progress on its objective of driving value through greater focus. Gross margins were in line with our targets as a result of strong execution and our strategy to focus on the business where our products are differentiated and valued. That being said, the LED market is experiencing softness in demand as global trade uncertainties persist. We remain focused on our target markets where we believe our customers value technology. We work with these customers to continue bringing innovations to the market and if needed, shift manufacturing capacities to Wolfspeed should the LED market continue to soften.

Wolfspeed achieved record results again in Q3 as revenue increased 72% year-over-year. Wolfspeed gross margin surpassed our targets and showed improvement year-on-year and quarter-on-quarter as the team continues to do an excellent job of balancing the challenges of rapidly increasing capacity while maintaining yield. Wolfspeed is now our largest business and represents 2/3 of our gross profit from continuing operations.

Cree's technologies are helping to power some major transitions in our economy. Whether it's the automotive industry's transition to electric vehicle or the telecommunications sector's moved to faster 5G networks, we are at the forefront of change. Our leadership in silicon carbide and GaN position us well in the marketplace to help customers improve performance and realize greater efficiency.

Our materials business continues to grow as the shift from silicon-based power and RF Power products most of silicon carbide and GaN technologies at an accelerating pace. As you may recall, we have already signed several long-term deals with major customers including STMicro, Infineon and others, which represent over $500 million in revenue. In addition to this success, we're currently discussing long-term supply agreements with additional partners and hope to finalize a few over the coming few quarters.

In RF, the wireless telecommunications market is rapidly moving towards GaN, which enables faster 4G and the transition to 5G. This is driven by GaN's inherent ability to provide wider bandwidth, higher frequency and higher efficiency and the outlook is very promising. Recent reports suggest momentum is building for 5G rollout in North America, China, Latin America and South Korea. As such, we're in the process of adding GaN production capacity to meet the increasing demand we are seeing. We will work very hard to expedite this capacity addition, but we anticipate demand exceeding supply for the next few quarters.

Car manufacturers continue to announce new investments in electric vehicle platforms and are increasingly interested in our silicon carbide technology. Our sales funnel is building nicely, and we now have an opportunity pipeline which is greater than $5 billion. Customer interest spans the globe as we're engaged in Europe, Asia and North America with many OEM and Tier 1 customers who have a strong interest in our silicon carbide technology. Now as I've mentioned in many of our previous calls, our path towards our long-term goals will not be a straight line. We have a lot of moving parts and we face a lot of challenges with the significant ramps ahead of us. Our production and our customer ramps will be lumpy. That said, our conviction about the transition from silicon to silicon carbide, coupled with the adoption of GaN technologies, is stronger than ever.

And to meet the growing demand for silicon carbide and GaN solutions, next week at the PCM -- PCIM show in Germany, we will outline our plans to further expand capacity. PCIM is the premier conference for power semiconductors, and I believe our customers will be excited to hear about our continued investment. When completed, this expansion will support our efforts to help customers make the transition from silicon to silicon carbide and GaN using Wolfspeed technology.

Our opportunity pipeline is larger than it's ever been, and the customer engagements with us continue to expand. We have a tremendous opportunity ahead of us and believe we are well positioned to capitalize on the excitement we see for our technologies.

And with that, I'd like to turn it back over to the operator so we can take any questions you may have.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from the line of Brian Lee from Goldman Sachs.

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Brian K. Lee, Goldman Sachs Group Inc., Research Division - VP & Senior Clean Energy Analyst [2]

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Maybe just on Wolfspeed to begin with. You said last quarter, Gregg, that Wolfspeed grew over 40% -- sorry, 50% organic year-on-year. Can you give us some sense for what that same metric was this quarter and then also what you're embedding into the guide here?

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Neill P. Reynolds, Cree, Inc. - CFO [3]

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Yes, Brian, this is Neill. Let me take a shot on that one. So for the current quarter just reported, that organic number is 40%, a little north of 40%. As you go into Q4, we don't have the repeat from last year on Infineon, so that's on a pure organic basis.

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Brian K. Lee, Goldman Sachs Group Inc., Research Division - VP & Senior Clean Energy Analyst [4]

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Okay. Fair enough. And then just I guess staying on the Wolfspeed topic for a second, the gross margins, it's encouraging to see margin expansion, ongoing margin expansion here. I know you guys have said time and time again that it won't be linear; you've got a pretty good job there. But just wondering, can you give us some of sort of puts and takes around how much of the margin expansion you're seeing recently into the fourth quarter is mix versus just improvements in the factory environment and volumes? And I'll leave it there.

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

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Well, I guess what -- I'll take a crack at that first and maybe Neill can provide some color to it. Our manufacturing team has just knocked it out of the park in terms of expanding the capacity and doing it at not only an incredible pace, but with super high quality. In fact, yields that we're getting out of our factories right now in silicon carbide production and the wafer fabs and so forth are at record highs. And what I would tell you is we still have some pretty nice room ahead of us to continue driving some of that.

So I don't know what the split is, but I would say a significant amount of the resiliency, if you will, on the gross margin is really coming from an execution perspective.

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Neill P. Reynolds, Cree, Inc. - CFO [6]

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Yes. Brian, this is Neill. So yes, I agree. We're certainly seeing benefits from the operations execution and that's kind of underpinning the gross margin performance in Wolfspeed right now. I will say though as we think about capacity expansions and as we work through these things, as we start bringing up different levels of volume and utilization of the factories as we move through these things, we may see some fluctuations in that as we move forward. But we're pretty happy with the performance thus far, and we like the road map that we got on the cost side.

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Operator [7]

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Our next question comes from the line of Jed Dorsheimer from Canaccord Genuity.

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Jonathan Edward Dorsheimer, Canaccord Genuity Limited, Research Division - MD & Analyst [8]

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Two. So I guess the first one, as we take a look at -- Gregg, as we take a look at the silicon -- the Wolfspeed business, I'm just wondering if you could provide any additional color on maybe platform wins or design wins. Because it would seem that with most of the business being successfully sold out on the base materials that the value proposition going from an IGBT silicon transistor to a MOSFET SiC is going to be really in the electric vehicle. And given the limited number that are out there, it seems like that's more of a 2020, 2021 kind of ramp. So your top line's going to be fairly limited as we metric you on revenue. So maybe some color on platforms or design wins might be a useful metric so we can better understand what the future might look like there. And then I have a follow-up.

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

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Yes. Okay, Jed. What I would -- we mentioned in the prepared comments that our opportunity pipeline is now over $5 billion. Obviously, that's substantially higher than -- well, it's the highest it's ever been, and that was substantially increased over this past quarter. We're not announcing specific design wins and so forth. I think your general thinking of the ramps happening in the 22x time period is on I think. If you look at the adoption rates for electric cars and the forecast that people are talking about, you're seeing noticeable increases in electric vehicle penetration happening in that 2021, 2, 3, 4, type time frame. What excites as about this whole thing is that we view it -- 2 things. One is the customers are really paying attention to the value of silicon carbide. What it brings basically is a lower systems cost and an ability for customers to stretch the mileage that they get out of a charge and that's obviously a big deal for customers of electric vehicles.

The additional thing that excites us is that even with a relatively low penetration of electric vehicles, the TAM is absolutely giant for silicon carbide. So we're probably looking at, and I've said this a couple of times, at least a decade and probably a multi-decade secular trend for us, so it's a really great long-term opportunity for us.

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Jonathan Edward Dorsheimer, Canaccord Genuity Limited, Research Division - MD & Analyst [10]

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Great. That's useful and helpful. Just shifting over to the gallium nitride on the Wolfspeed, I'm curious how we should think about the difference between manufacturing on the LED and the powered GaN from a, maybe GaN thickness perspective or chip size, or how to think about the difference between the LED business and Power for base stations?

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

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Well, the GaN itself, what I would say is from a manufacturing perspective, the base material is silicon carbide, relatively similar and certainly the manufacturing asset associated with building a silicon carbide LED wafer and a silicon carbide wafer that ends up with GaN on top of it, that base manufacturing is relatively -- basically very similar. And so we've got a high degree of fungibility on that.

From a wafer fab perspective, it's also highly fungible but our ability to ramp that really depends on us qualifying that GaN wafer processing in the LED factory. That's what we're in the process of doing right now. As I mentioned in the prepared remarks, the RF appetite for GaN right now, based on the rollouts of these new networks, is very, very high, and we're really struggling to keep up with demand. In fact, we're not keeping up with demand. And so we've got a pretty significant focus in our company right now to fix that. I think we've got a couple of quarters ahead of us to do that.

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Operator [12]

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Our next question comes from the line of Joseph Osha from JMP Securities.

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Joseph Amil Osha, JMP Securities LLC, Research Division - MD & Senior Research Analyst [13]

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Kind of a follow-on from the previous question talking about the RF business. Are you more inclined at this point to sell other people GaN and SiC wafers? Or are you more inclined to try and sell finished PMs as components? And then I have a follow-up.

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

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Joe, we're equally happy to do both. We believe that we are in a transition. An industry's transition in semiconductor is very, very rare. And that is a transition from semiconductor-based capability to a -- or a silicon-based capability to a silicon carbide and GaN capability across the Power businesses and the Power RF businesses.

And so our view is, to the extent that we can continue building out a materials business and servicing that industry, it's going to help the overall semiconductor industry flip from silicon to silicon carbide. We obviously utilize some of that technology internally to develop solutions with customers and so forth. But we're working both of these aggressively and we've got very good partnerships with many of the -- with all of the people that we've signed these long-term contracts with. So we're perfectly happy doing both.

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Joseph Amil Osha, JMP Securities LLC, Research Division - MD & Senior Research Analyst [15]

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Okay. And then next question would be you alluded to the Chinese EV market and some of the machinations there. I mean given the many, many, many opportunities that you have in front of you at this point and the fact that Chinese market can be a little janky, I mean have you perhaps thought about maybe redeploying a little bit and saying, hey, we're going to perhaps reallocate a bit away from the Chinese EV market in favor of other things? I'm just curious about your strategic reaction to this softness.

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

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No, not at all. I think what I would say is, we believe that this is a -- this is something that's happened because incentives have gone away. Perhaps customers were buying ahead of incentives going away. There still are a lot of really -- the trend for electric vehicles in China I think is going to be non-stoppable. The country is moving very, very quickly to try to drive more adoption of electric vehicles. They've -- incentives that will remain in place, will be in place, will favor vehicles that get longer driving distances, which is a benefit, obviously for -- that silicon carbide provides. We view that this part of what's changing is going to be an additional tailwind, if you will, for customers now switching their drivetrain, more of their drivetrain to silicon carbide.

China also has announced that they are demanding, I guess is the right way to say it, that all the large cities convert their buses to electric or non-combustion engine buses by 2022, and those buses are going to require a lot of energy obviously as well. And so we believe those are going to be high-voltage solutions that are going to require high efficiency, which is a good thing for silicon carbide. So we're not blinking at all when it comes to that.

That being said, Joe, as I mentioned in the prepared comments, our engagements right now our global. I was in Asia for 2 weeks a couple weeks back and visited with folks, of course, in China but also throughout Asia. I'll be in Europe next week at the PCIM show, visiting with customers and OEMs and Tier 1s and so forth. We've got visits in North America all set up.

I think the trend towards electric vehicles is happening globally, and I think it's a secular trend that's going to happen -- that's going to continue for quite some time.

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Operator [17]

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Our next question comes from the line of Harsh Kumar from Piper Jaffray.

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Harsh V. Kumar, Piper Jaffray Companies, Research Division - MD & Senior Research Analyst [18]

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I was looking for an update on the silicon carbide materials segment. It appears it's hand to mouth as far as supply is concerned. You do have long-term contracts. Was wondering if you could give us an idea of how long a visibility you have on your supply being snatched up by customers? In other words, when we ask some of the other companies say they are sold out for a year, sold out for 2 years. Is there a number like that, that you could share?

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Gregg A. Lowe, Cree, Inc. - President, CEO & Director [19]

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No, I don't think of it that way because we're obviously still in the process of signing up other folks. Next week, we'll be talking about additional capacity expansion plans. And so what I would say is stay tuned. Tuesday next week, we'll be making that announcement, and you'll get a little bit more color on that. And I think we have pretty good visibility based on the number of long-term supply agreements that we have right now. Some of those agreements, well, all of those agreements have some amount of upside flexibility, and we've already seen customers accept initiating those upside requests. So we feel pretty good about that.

And then as I mentioned as well, we're in discussions with a number of other companies on these long-term agreements. And we're very hopeful that we'll have some announcements in the coming couple of quarters.

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Harsh V. Kumar, Piper Jaffray Companies, Research Division - MD & Senior Research Analyst [20]

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As my follow-up, if you didn't have this issue in China with EV, in other words, if Power business had stayed intact, how fast do you think Wolfspeed would have grown?

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

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It's hard to say. This is Neill. I think if you look at the growth and the guidance we've given, I think year-over-year in fourth quarter we're still approaching 30% year-over-year. So I think we've got very solid growth across the businesses in Wolfspeed. We talked about the demand being very strong for materials and RF, which is certainly the case. But even year-over-year, the growth in Power and Power devices is still a big piece of the equation there. So I can't say exactly where we would have been, but there's still strength year-over-year.

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Operator [22]

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Our next question comes from the line of Sidney Ho from Deutsche Bank.

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Shek Ming Ho, Deutsche Bank AG, Research Division - Director & Senior Analyst [23]

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I have a couple. On the -- there has been a lot of talk about 5G being pulled forward on the infrastructure side. Looks like you are seeing the same trend, you have pretty good -- geographically, it seems to be pretty wide as well. Can you give us some color around the magnitude of the growth you have seen? Is that or do you expect that business to grow faster than your substrate business? And is that business already bigger than substrate, which I think it was the biggest segment within Wolfspeed?

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

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What we've mentioned -- well, first off, the 5G, describing that as a pull in might be a little bit of an understatement. It's been a pretty significant demand upswing that we knew it was going to grow, but it grew obviously a lot faster than we were ready for. So we're kind of swimming upstream installing capacity and so forth. And that requires wafer fab-type stuff, which is obviously a little bit more difficult, and that's what's going to be a couple of quarters for us. So very nice growth rate. We obviously are very excited about demand growing, and we're working very hard with our customers to give them sort of daily updates and so forth on all of that.

In terms of the materials business, what I've said before us over the span of our long-term plan, which we talked about, about a year ago going through 2022, all 3 of our businesses are going to grow pretty rapidly. Our Power business is going to grow rapidly, our RF business going to grow rapidly and our materials business is going to grow rapidly. I would anticipate, the materials business is probably going to grow faster certainly over the early part of that near term just simply because there's more channels to market. They sell materials to customers that have significant more feet-on-the-street, if you will, and so I think that'll grow very nicely over that time period. But all 3 of them are going to grow nicely over that time period.

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Shek Ming Ho, Deutsche Bank AG, Research Division - Director & Senior Analyst [25]

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Okay, great. Maybe my follow-up question is on the substrate side, on the competition side. With one of your customer that has long-term supply contract with, investing in another silicon carbide wafer manufacturer in Sweden, how do you see competition shaping up? And how do you think that may change your pricing strategy and maybe your margin expectations going forward?

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

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Well, let me talk a little bit about pricing. We know that there is a decision that customers are making between silicon and silicon carbide. They look at the silicon carbide and they see all the advantages and then they have to weigh that against the cost differences between the 2. And so one of the key things we've been driving over the last 18 months is a continued focus on driving the cost delta between silicon and silicon carbide down. We've done that through multiple different initiatives. One is obviously the expansion of our scale and with that scale goes up, our absorption of fixed cost goes down and we get a lower cost per wafer, cost per crystal, et cetera.

The second piece to that, though is very important piece as well and that is as our scale goes up, our learning for manufacturing goes up dramatically as well. We apply that learning for manufacturing to the manufacturing process itself and our yields go up. And so the same fleet is now yielding more, which drives our cost down. We believe we've got some pretty good headroom still in front of us in terms of where we think we can get to from yield perspective. So we're going to continue driving that.

And so all of that cost, it gives us an opportunity then to really expand the adoption of silicon carbide because the advantage now not only outweighs what would be a normalized silicon carbide to silicon delta, but rather a decreased point between the 2.

And as we do these longer-term supply agreements with customers, our pricing strategy is relatively straightforward. Customers that sign up for long-term agreements with us, they get access to pricing curves. We obviously don't give it all away, but they get access to those pricing curves. They get guaranteed supply and we get good visibility in terms of what they need. So I think the pricing is a relatively straightforward thing. What we're really trying to do is convert an industry from silicon the silicon carbide.

Now all that being said, we know that there's competition. And so what we need to do is just continue running faster than others. We've got a sizable footprint advantage in terms of the size of our materials capability. We've talked about expanding that capability before and increasing that size, and next week we'll be talking about an incremental addition to that capability that will further extend our capacity and our capability, which, again, should allow us to further serve the needs of our customers but also drive cost down. So it's all -- we're sort of at the early part of this whole game. There's nobody in this company that is sort of dropping the ball on the 5-yard line. We've got a lot of work to do. We know that the industry sees this tremendous transition from 4G to 5G and LDMOS to GaN. We see -- the industry sees the transition from internal combustion to electric vehicles and therefore, from silicon-based solutions to silicon carbide-based solutions. So I think it's well known in the industry that there's going to be a lot of opportunity, and our job is to stay in front of that, ahead of that and to service our customers in ways where they're excited to continue working with us.

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Operator [27]

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Our next question comes from the line of Craig Irwin from Roth Capital.

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Craig Edward Irwin, Roth Capital Partners, LLC, Research Division - MD & Senior Research Analyst [28]

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So first thing I wanted to ask about is the breadth of the -- which is called sequential flattening of growth. Can you maybe clarify for us whether or not this might be 1 or 2 large customers, maybe recalibrating their forecast and leaning out the supply chain while the remaining customers are all recording similar growth to what we've seen over the last couple quarters? Is that the dynamic? Or are we looking at something that's a little bit more broad-based?

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

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No, I think it's really focused on China, and it's focused on the China electric vehicle market and the subsidies going away. So I'd say it's relatively focused on that, Craig.

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Craig Edward Irwin, Roth Capital Partners, LLC, Research Division - MD & Senior Research Analyst [30]

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Great. Second question is your inventory, right, for a company that's completely sold out, we talk to customers minimum 6 months lead time on MOSFET orders, unless someone's a very important customer. Wafers, very much the same thing, I guess, unless you're buying just a few. Inventory seems like it could be a little bit high. Is this something structural in the business related to the processing and production of wafers? Maybe can you comment for us what your inventory would look like if you were to procure wafers externally and simply produce components and chips for external customers?

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Neill P. Reynolds, Cree, Inc. - CFO [31]

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Craig, it's Neill. Let me just hit on the inventory. I think there's a -- if you look year-over-year there's an inventory increase. Most of that's related to LED and we talked about some of the market softness there. We're going to pull down our factory volumes to help manage some of that.

Once you take away the Lighting business, that puts at 90 days as a company. I don't think that's a bad place for us to operate at given what we need to try and accomplish. So we really got to balance 2 things there. We still have the LED business, we got to balance some of the softness and manage that inventory.

And as it relates to Wolfspeed, we're driving the capacity expansion absolutely as hard as we can to help manage the business and manage the opportunity. But I feel like the inventory level just kind of match our ability to kind of move over there.

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Operator [32]

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(Operator Instructions) Our final question in queue at this time comes from the line of Colin Rusch from Oppenheimer.

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

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Can you talk within that sales funnel about how many Tier 1s and auto OEMs are actually in advanced testing on your silicon carbide MOSFETs?

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

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I won't give that level of detail. What I would tell you is we are engaged with many Tier 1s directly in terms of helping them understand what we're doing from a silicon carbide perspective and specifically what we're doing from a capacity perspective. They have a lot of interest in that. We're involved with OEMs as well. And so that sales funnel spans as I mentioned earlier, across a large number of customers, a large number of OEMs and Tier 1s and across the globe.

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Colin William Rusch, Oppenheimer & Co. Inc., Research Division - MD and Senior Analyst [35]

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Okay. And then on the LED business, as you look at some of these cycles and some of the softness in that business, are there structural things that you can do, additional measures that you can take to make that business just a bit more resilient as you go forward?

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Neill P. Reynolds, Cree, Inc. - CFO [36]

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Yes, thanks for the question. So if you look at LED business, as we move in from Q3 to Q4, normally you'd see a seasonal balance coming out of Chinese New Year between 5% and 10% revenue growth. Obviously, we've just guided down 5%. And with that, we're going to take the factory volumes down. Now we've always known that was a potential scenario. And what we've said before is if that were the case, we would take that capacity and move it over to Wolfspeed. So that's kind of the plan we're running. So we're going to take the capacity, move it to Wolfspeed. We talked earlier about doing that in materials, and we can do that more quickly and then we'll work the fab piece as well over a little bit longer of a period of time. But the idea again is, on LED is really just to focus that business where we need it and optimize where we drive value for our customers, and then focus our fungible capacity over to Wolfspeed.

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Operator [37]

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And we have a follow-up from the line of Joseph Osha from JMP Securities.

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Joseph Amil Osha, JMP Securities LLC, Research Division - MD & Senior Research Analyst [38]

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I was kind of surprised this didn't come up, so I figured I'd ask it. Gregg, can you talk a little bit about your -- how the progression looks in terms of wafers sizes and what you're thinking there in the SiC business?

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

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Sure. Thanks, Joe, for the follow-up. We're converting -- we've converted a lot of our capacity from 100-millimeter to 150-millimeter. We're in the process of doing that with our RF business as well. So I'd say we're in the ramp process, if you will, of 150-millimeter, and I anticipate of that we'll be on 150 millimeters for some time. So we obviously have R&D and developments going on, on expanded wafer dimensions and sizes and so forth, but nothing really to report at this point. We're really focused right now on ramping the 150. What's really nice is that the quality of crystal that we're getting at 150, the quality of yield that we're getting at 150, the quality of wafer fab -- the quality that comes out of our wafer fab at 150 is rock solid. So we're really -- we're super happy about what we've done at 150-millimeter.

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Joseph Amil Osha, JMP Securities LLC, Research Division - MD & Senior Research Analyst [40]

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And just does 4-inch go away entirely at some point?

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

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Yes, it will go away. I don't know to 0 depending on we've got some customers that require long, real long cycles. So but it'll go below 5% at some point, I would say in the near future.

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Operator [42]

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This does conclude the question-and-answer session of today's program. I'd like to hand the program back to Gregg Lowe for any further remarks.

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Gregg A. Lowe, Cree, Inc. - President, CEO & Director [43]

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Well, thank you, everybody, for your time today. We're pleased with our progress in the quarter and we'll continue to make the necessary investments to grow our market leadership position.

Please watch out for our expansion announcement next week, which will be on Tuesday. And please let us know if you have any further questions.

Thanks and have a great evening.

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Operator [44]

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Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.