Logo of jester cap with thought bubble.

Image source: The Motley Fool.

Cree Inc (NASDAQ:CREE)
Q1 2020 Earnings Call
Oct 30, 2019, 5:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Ladies and gentlemen standing for standing by, and welcome to the Cree Fiscal Year 2020 First Quarter Earnings Call. [Operator Instructions]

I would now like to hand the conference over to your speaker today, Mr. Tyler Gronbach, Vice President of Investor Relations. Please go ahead, sir.

Tyler Gronbach -- Vice President, Investor Relations

Thank you, Liz, and good afternoon, everyone. Welcome to Cree's first quarter fiscal 2020 conference call. Today Cree CEO, Gregg Lowe; and Cree's CFO, Neill Reynolds will report on the results for the first quarter of fiscal year 2020.

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.

During the Q&A session, we would ask that you limit yourself to one question and one follow-up so that we can accommodate as many questions as possible during today's call. If you have any additional questions, please feel free to contact us after the call.

And now, I'd like to turn the call over to Gregg.

Gregg Lowe -- President, Chief Executive Officer, Director

Thanks, Tyler, and good afternoon, everyone. Cree's strategic transformation remains on track. We're extremely excited about the future of our business and the opportunities ahead as the adoption of silicon carbide across multiple sectors continues to grow. In the fiscal first quarter, we delivered results that met or exceeded the upper end of the ranges we set for revenue, gross margin and EPS.

We continue to see strong momentum and growing interest in our silicon carbide and GaN technologies. As we've said on previous earnings calls, we continue to confront some headwinds related to geopolitical and macroeconomic issues, and we don't expect this to change in the near term. However, our teams' experience with managing through various cycles and their track record of growing businesses over the long term will help us navigate through this period. Our singular focus remains on positioning Cree to compete and win for the exciting opportunities we see in front of us.

I'll now turn it over to Neill, to provide some additional color on the financial results and the outlook for next quarter.

Neill Reynolds -- Chief Financial Officer, Executive Vice President

Thank you, Greg. For the first quarter of fiscal 2020, revenue decreased 11% year-over-year to $243 million due to 22% lower LED segment revenue amid soft market conditions and ongoing trade and tariff concerns with China. Wolfspeed revenue increased modestly as compared to the year ago quarter.

Non-GAAP EPS was a net loss of $3.6 million or negative $0.03 per diluted share. Our non-GAAP loss per share was slightly better than the midpoint of our target range due to better than expected gross margin in our LED business, while Wolfspeed gross margins were in line with our target.

Our first quarter non-GAAP earnings exclude $33 million of expense net of tax or $0.31 per diluted share from non-cash stock-based compensation, acquired intangibles amortization, accretion on convertible notes, transformation and transaction related costs, factory optimization restructuring costs and other items outlined in today's earnings release.

Our fiscal first quarter 2020 revenue and non-GAAP gross profit were as follows: Wolfspeed quarterly revenue was essentially flat year-over-year, but down 5% sequentially to $128 million in line with our targets. We continue to see softness in China related to the change in EV subsidies earlier this year. This marks the third consecutive month of weaker automotive sales trends in China. In our RF business, in addition to Huawei, we are seeing some push outs and delays in purchasing activity as it relates to the rollout of 5G networks.

Wolfspeed gross margin was in line with our targets at 46.3%, a decline of 390 basis points sequentially as customer mix related to the Huawei ban impacted margins. LED products revenue was above our target range at $115 million, but declined on a sequential basis due to ongoing global trade uncertainties. LED gross margin was 19.2%, down 490 basis points sequentially, primarily due to lower factory utilization. LED gross margin exceeded our target driven by improved customer mix and cost execution.

Unallocated costs totaled $4.8 million for the first quarter of fiscal 2020 and are included in our overall cost to reconcile to our $76 million non-GAAP gross profit for -- or 31.5% total gross margin for the company. Non-GAAP operating expenses for Q1 were $84 million, slightly above our target of $83 million. Our non-GAAP operating loss was less than the midpoint of our target at $8 million. Our non-GAAP tax rate was in line with our targets at 14%.

During the first quarter, cash from operations was an outflow of $20 million and capital expenditures were $43 million, resulting in negative free cash flow of $63 million as we continue to invest for growth to expand capacity in our Wolfspeed business. We ended the quarter with approximately $1 billion in cash and short-term investments, zero balance on our line of credit and convertible debt with a face value of $575 million.

For the quarter, days sales outstanding came in at 39 days and inventory days on hand improved to 98 days from 104 days last quarter. For fiscal 2020, we continue to target capital investments of approximately $200 million. Our capital allocation priorities remain focused on expanding capacity in our Wolfspeed business to support anticipated demand.

Turning to the outlook for the second quarter of 2020, we are targeting revenue in a range of $234 million to $240 million based on the following segment trends. Wolfspeed revenue is expected to be down on a sequential basis, approximately minus 6% to 3% as we continue to deal with the impact of the Huawei ban, softness in 5G network spending and lower electric vehicle sales in China. We continue to comply with U.S. federal law as it relates to Huawei and we have applied for licenses from the government to potentially resume certain shipments to our customer, but we are still awaiting a response. LED revenue is expected to be flat on a sequential basis, as we don't see any material change in the LED market outlook.

We target Cree's Q2 non-GAAP gross margins at approximately 30% based on the following segment trends; we target Wolfspeed gross margin to be between 41% to 44%, down approximately 400 basis points sequentially driven by lower factory utilization to manage our short-term inventories, a significant scrap event and lower than expected yields as we ramp our 150-millimeter MOSFET product. We see these items as temporary. Utilization effect should reverse when volumes recover and we have plans in place to improve the 150-millimeter MOSFET yields. However, it will take one to two quarters for margins to improve once volumes increase and improvements are implemented on 150-millimeter MOSFET yields.

We are targeting LED gross margin to be between 19.5% to 20.5% modestly up on a sequential basis. We are targeting Q2 non-GAAP operating expenses to be slightly higher on a sequential basis at approximately $85 million as we continue to invest for growth in our Wolfspeed business and align our LED cost structure to the current environment. As we have stated 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 Q2 non-GAAP operating loss from continuing operations to be between $17.6 million to $11.3 million and we target non-GAAP non-operating income to be approximately between $2 million to $3 million. We expect our non-GAAP effective tax rate to be approximately 1%. We are targeting Q2 non-GAAP net loss to be between $12 million to $8 million or a loss between $0.11 to $0.07 per diluted share. Our non-GAAP EPS target is lower by approximately $0.02 due to the ongoing impact of the tariffs. Our non-GAAP EPS target excludes acquired intangibles, amortization, non-cash stock-based compensation, accretion on our convertible notes, transformation 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 or incremental inventory reserves related to the Huawei ban. Our Q2 targets are based on several factors that could vary including overall demand, product mix, factory execution and the competitive environment.

I will now turn the discussion back to Gregg.

Gregg Lowe -- President, Chief Executive Officer, Director

Thanks, Neil. Before I review a few key developments related to the strategic transformation of Cree, two quick thoughts on the operating environment and the business. The near-term environment remains fluid for us. Customers are being more cautious as trade concerns linger, the rollout of 5G is delayed and EV sales in China are down. Additionally, as I've mentioned on previous occasions, as we significantly increased our capacity, we are bound to face some manufacturing challenges. This quarter, that happened. We had a significant scrap event and overall lower yields on our 150-millimeter ramp in our Durham fab impacting our gross margin in the near term. We have a clear understanding of the issue, and are implementing improvements as we speak and expect to resolve these issues and get the yield back to target in short order.

Now, looking at our progress in the quarter. We are continuing with our efforts to increase the availability of silicon carbide as customers look to leverage our Wolfspeed solutions to drive innovation. Our updated expansion plans and partnership with the state of New York for an automated silicon carbide wafer fab is a critical element of our strategy. We are establishing a silicon carbide corridor on the East Coast of the United States, anchored by a mega materials factory on our headquarters campus in North Carolina and a large wafer fab in the Mohawk Valley region of New York. The mega materials factory expansion has been ongoing for some time, as we have installed new crystal growers, shifted more LED growers to Wolfspeed and drove improved productivity across the entire fleet of growers. While we are at the early stages of the creation of the Mohawk Valley fab, the teams have already shifted the prep work into high gear and we expect the work on the site to begin soon.

In fact, just two weeks after we announced our partnership in New York, we successfully ran our first silicon carbide test wafers at Sony Albany. The prototype line in Albany was part of the overall incentive package and allows us to de-risk the start-up of a new fab. This first run is a small but significant step toward a very promising future for the Mohawk Valley fab. This is a very capital efficient way to build two high-quality modern facilities to support the growing demand we expect from the automotive, communications infrastructure and industrial segments.

Second, we were extremely pleased to have announced our partnership with Delphi Technologies to use Wolfspeed silicon carbide based MOSFETs for their 800 volt inverter with production beginning in 2022.The auto industry represents one of the most significant multi-year opportunities for silicon carbide and this partnership is a strong endorsement for Cree in the device area. Across the automotive space, there is strong interest in the application of silicon carbide to the electrification of the powertrain. Silicon carbide has better power density and efficiency, enabling electric vehicles with silicon carbide-based systems to have a greater range compared to those with silicon for a given battery size.

OEMs and Tier 1s are recognizing the significant benefits of silicon carbide over silicon, and we are actively engaged in multiple conversations at the highest levels of many of these organizations. Some of these conversations are at the early stage, while some are in the final stage where we expect a decision very soon.

Beyond electric vehicles, the benefits of silicon carbide carry over to other end markets including telecom, infrastructure, solar, industrial and other applications. Across our end markets, Cree is engaging with innovative companies who are running up against the limitations of silicon to help them break through and deliver the promise of their next-generation applications, and our leadership and expertise positions us well with many of these innovators.

Roughly $9 billion opportunity pipeline remains robust and we are working hard to convert opportunity and the design wins. Over the coming six to 18 months, customers target to make sourcing decisions on a sizable portion of that pipeline. I'm personally involved in a lot of customer meetings regarding these programs and believe we are well in the mix when it comes to a final decision.

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

Questions and Answers:

Operator

[Operator Instructions] Our first question comes from Brian Lee with Goldman Sachs. Your line is now open.

Brian Lee -- Goldman Sachs -- Analyst

Hey, guys. Thanks for taking the questions. Maybe to start off on gross margins, I just want to clarify is the scrap event related to wafers or is it related to the MOSFET's? I didn't know if there were two separate issues. And then when you talked about utilization coming back and then needing one to two quarters to see margins recover from the yield issue. Are you referencing back to sort of the mid 40% level assuming the same mix with Huawei as of recently or are you referencing kind of back to the high 40%s that you were running at before the customer mix issues? And then I have a follow-up.

Neill Reynolds -- Chief Financial Officer, Executive Vice President

Yeah. Sure, Brian. This is Neill. Let me just hit that one first, and I think it's probably worth on attacking the kind of the gross margin kind of quarter-over-quarter here. So on the 150-millimeter scrap that's related to the MOSFET, OK. So we see that as -- obviously, we talked about this before, as we ramp and we have a number of different things going on in the factories and movements between factories, and then we're ramping a number of new technologies, something like this can happen and so that's kind of the case here. So we've identified the root cause of the issue -- as we talked about, we're implementing the improvements. And the one to two quarters is really about just getting through a cycle, so I think that's kind of kind of where we were before as we started the quarter.

As it relates to the utilization, I think that's important as well, so that really has two parts to it. The first one is utilization in the materials factory. So what's going on there is, the growth in capacity is outpacing our growth in output in the materials factory, and that's really driven by two things; one is, we've effectively transitioned a lot of the LED capacity for crystal growth over to Wolfspeed, and the second one is, that we've had really solid execution on the productivity initiatives within the materials factory. So you put both of those two things together and well I think utilization down a little bit here. That's really kind of a good thing for us from a cost standpoint, so if you think about it both from a transitioning crystal growth from LED to Wolfspeed and driving productivity programs, that's actually going to help us drive more output over the same fleet and drive our cost down. So from a cost standpoint, we're seeing a lot of improvement in the materials factory. Here in the short term, though, we're going to see some utilization benefits and that'll take just go through inventory cycle that get us through that again we see both of these items as temporary.

Brian Lee -- Goldman Sachs -- Analyst

Okay, fair enough. That's helpful. And then maybe just on the growth side of things again, more focused on Wolfspeed but the guidance for the second quarter. Obviously, there's still some near-term headwinds embedded in the view here. Just wondering if you could entertain any thoughts on seasonality as you think about the fiscal third quarter across the two business segments? And then when you think about the impact of EV subsidy timing. I feel like that's been mentioned about three or four quarters running here. When do you kind of see that lapping as being a headwind in that part of the business for you from a China EV perspective? Thanks guys.

Neill Reynolds -- Chief Financial Officer, Executive Vice President

Thanks, Brian. Let me, this is Neill, I'll take a shot at that. So 1Q moving to 2Q obviously the Wolfspeed revenue outlook is down roughly 5% at the midpoint. The primary driver of that is the -- is RF and that's related to kind of lower spending in 5G networks. And as you mentioned the Power business continues to see some slowness or weakness related to the China EV market. So as you look out beyond 2Q, we are seeing growth in the materials business and we would expect that to continue. The rest of the outlook is, I'd say, it's really difficult to call, the macro environment has a lot of different things going on. You have, as you mentioned, the EV subsidy issue, maybe a pause as we're seeing it in the 5G kind of rollout and spend. We continue to be -- have the bandwidth Huawei. And then on the trade and tariff concerns that just continues to be up and down in terms of news there. So all we can really do at this point is assume that the environment kind of remains the same for the next couple of quarters as it relates to the kind of RF and Power business, and that's kind of how we're thinking about it.

Gregg Lowe -- President, Chief Executive Officer, Director

Yeah. And I'll just add -- just a little bit more color from my perspective as well. First off, Neill said it well, but we have been in the midst of a significant ramp in this scrap issue and the lower yield definitely hit us this quarter. But we've now had two solid years of unbelievable execution nearly flawless execution. So this hit us now, it's unfortunate, we've got it well understood. We got implementation of fixes in place right now and it's really just a manufacturing cycle to get through -- to get those yields back up where we want them to be. And then in terms of the EV incentive changes in China, longer term, it's going to -- the changes are actually more favorable for us, because there is two aspects of the change, one is really favorable for us, and that is the incentives are being put on cars that have longer range. And the primary benefit of using silicon versus silicon carbide is in a vehicle is that for the same battery size you get longer range. And so, we think the Chinese are going to be shifting their development activities toward that and ramping up these longer-range cars over time.

The second benefit is that the Chinese -- most of the Chinese cities are eliminating the wait time for registrations on electric vehicles, and my understanding is registering the car in China can take quite a long time and so that wait time for EVs is basically going to go to zero. And so that eventually will be a positive thing for us as well.

Operator

Our next question comes from the line of Jed Dorsheimer with Canaccord Genuity. Your line is now open.

Jed Dorsheimer -- Canaccord Genuity -- Analyst

Hi, thanks. Thanks for taking my question. I guess first one just in the gallium nitride business for the power amplifiers and I'm curious, when do you expect non-Huawei carriers to start adopting gallium nitride in the rollout. Is that a qualification issue that's limiting that or are we just not in the capital deployment part of the 5G cycle there?

Gregg Lowe -- President, Chief Executive Officer, Director

I think Huawei has clearly been the most aggressive in terms of the adoption of gallium nitride and best we understand that they haven't done a non-GaN type new development in a number of years. So they've been really leaning forward on that. And other base station manufacturers are developing products with GaN but it was just at little bit slower pace.

Jed Dorsheimer -- Canaccord Genuity -- Analyst

Got it. And so is that -- if we looked out should we expect that for sort of fiscal 2021 type of time frame, again with the caveat that obviously things are fluid in the market, but is that sort of the timeframe that you're planning too there?

Gregg Lowe -- President, Chief Executive Officer, Director

Maybe, Jed, but what I would say is there is kind of another element of this whole story and that is the biggest market for 4 or 5G is likely going to be China. The biggest player is Huawei in that market and best we can tell from the data that's out there. The thought process that non-Huawei players who are going to pick up that business in China doesn't seem to have played out that way at least at this point. So I don't know exactly what that means and when that transition happens with other players picking a part of that, but at least at this point, it's been now 5.5 months since the entity list came on board and that doesn't seem to have happened?

Jed Dorsheimer -- Canaccord Genuity -- Analyst

Got it. That's helpful. Thanks. Just moving over to the silicon carbide, the Tesla solution uses one inverter module per motor. So where we in a car that has all-wheel drive, that's two motors. What we're seeing is designs that are different than that out of other EV manufacturers. Do you think that the market will standardize on sort of that Tesla design or do you think it'll be equally shared because obviously that's going to have a pretty big impact on the silicon carbide content if you potentially have two slots or two modules per vehicle versus one?

Gregg Lowe -- President, Chief Executive Officer, Director

We're working with number of different customers that have a variety of different architecture. Some of them have four modules placing one on each wheel. I think it's way too early to tell in the EV market what's going to be the standard or if there is even going to be a standard anytime soon. What I would tell you is the car manufacturers; the OEMs view the engine of the car is sort of the heart and soul of the car. And so they want to performance that they want. They want the soul of the car to become in sort of their image of what they want the driving conditions to be. So I would imagine there is going to continue to be a number of different architectures that are out there, we're engaged in, with most of the Tier 1s and the OEMs in discussions on what these architectures look like.

But what I'd also tell you is that the interest in silicon carbide for the inverter has gone from -- we're going to think about it to -- it's likely going to be the solution. So I feel very comfortable that the -- when you look at our design pipeline that -- about half of the $9 billion is related to automotive. I would say, the probability of that pipeline being decided as silicon carbide versus silicon is extremely high. And I would say, we're just working really hard to make it a Cree-based solution.

Operator

Our next question comes from the line of Craig Irwin with ROTH Capital Partners. Your line is now open.

Craig Irwin -- ROTH Capital Partners -- Analyst

Hi, good evening and thanks for taking my questions. So Gregg, when we look at the big picture, right. Your $9 billion pipeline, the activity with customers, we can name like Delphi, Tesla, VW, Porsche. It's pretty easy to put together a longer-term picture, a longer-term growth story where we can have confidence in some fairly significant growth. But in the short term the shape of the curve is a little bit difficult to predict. Can you maybe describe for us what you think is a likely trend for the back half of this fiscal year? And how we're likely to see customers like Delphi materialize, as material revenue contributions over the next couple of years?

Gregg Lowe -- President, Chief Executive Officer, Director

Yeah. So what I would say, well first off, on Delphi. I think it was in the announcement that's a 2022 ramp and that would be kind of normal for automotive type applications. So it's decided in 2019 and few years later. It's going to ramp up. That's very, very normal. I've been in this industry for a long time and that would be kind of a normal ramp. And so, as far as the pipeline goes, that's related to automotive and about half of that pipeline is automotive, another part of it is RF, another part of it is industrial type applications. So those are going to have a little bit different ramps on those. But for the automotive part of it, you're going to really see that really happening in the later years or in 2022 and beyond.

In terms of the back half of this year, it's really -- it's uncertain environment right now, in fact, it's an unprecedented environment where we've got a trade conflict. I think has lasted a lot longer than anyone was thinking would last. You've got an entity list that starts with the largest supplier base stations in the world and now different companies being added to entity list, you got a lot of concern, you've got a slowing growth in China, you got EV subsidies changing and all that kind of stuff, so I think for the near term, it's just -- it's going to be lumpy and uncertain. But I think as you stated Craig the longer-term looks actually quite solid and I think we feel better about it today than we did last quarter and the quarter before that.

Craig Irwin -- ROTH Capital Partners -- Analyst

Great, thank you. My second question is really about China. So if we look at Huawei, Chinese EV some of the network spending that's supposed to happen over there, these have been headwinds for you in the short term. Can you maybe describe what's in your guidance for the second fiscal quarter as far as contribution from these different end markets? And can you maybe approximate for us what the magnitude of the headwind was in the quarter and what do you think it's likely to be as we progress throughout the year?

Neill Reynolds -- Chief Financial Officer, Executive Vice President

Hey, Craig, this is Neill. I'll take a shot at that. So going into 1Q, we knew we had the effect of the Huawei ban. So let me just put that to the side for a second. As you start to look into 2Q and even beyond, I think you kind of have a similar type of profile here. We're seeing some growth in the materials business as I kind of mentioned earlier. But if you go into 2Q, I think the big difference versus 1Q is the kind of the non-Huawei kind of RF customers and kind of a slowness or weakness there in terms of the 5 G spend. So I think that's what's impacting us now.

As you get out beyond 2Q and you start to look at those pieces, the device businesses out for the rest of the year, for all those factors we just talked about, it's difficult to call. So again, we just have to assume based on all those factors that everything is going to be more or less the same as it is right now as you look at the back half of the year and that's how we're kind of thinking about it and I think that's about as much context as we can give, given the uncertainty and what we're looking at.

Gregg Lowe -- President, Chief Executive Officer, Director

Yeah. And you know, I said that we're kind of in an unprecedented time. It -- one day you will see a new flash that we're really close and we're going to sign a deal next week with China and then the next week it actually gets worse. So I think we're managing through it, best we can, but it doesn't deter us at all from the long-term and even the mid-term. I think the -- we're in a very, very nice secular space with the adoption of EV really rolling very, very strong and the design win pipeline continuing to be very solid.

Operator

Our next question comes from Gary Mobley with Wells Fargo. Your line is now open.

Gary Mobley -- Wells Fargo -- Analyst

Hey, guys. Thanks for taking my question. I wanted to ask about different operating expenses and maybe even cost of goods sold expenses as you work to ramp your Utica facility and [Indecipherable] in North Carolina. So yield issues notwithstanding, how do you see the expenses rising as we ramp up to that full production ramp in Utica, I know that opex have been increasing roughly $2 million to $2.5 million per quarter over the last couple of quarters, is that sort of the trend line that we should be thinking about?

Neill Reynolds -- Chief Financial Officer, Executive Vice President

Yeah. Thanks, Gary for the question. I think if you pull apart our opex. I think the way you want to think about it. We have to have two things going on. First is, we have an LED business, which has obviously seen a weaker environment. So we're taking costs down related to LED and we're kind of ensuring that we've got that opex structure kind of aligned to what we're looking at in the market. On the opposite side, as you kind of talk about in Wolfspeed, we're going to continue to invest in that. And right now, we've seen that tick up here a little bit quarter-by-quarter, we expect to see kind of the same type of rate as you look out to the rest of the year. As we get to the Investor Day here in a few weeks, we're going to kind of lay out a little bit more in terms of what that opex model will look like in terms of Mohawk Valley fab and some other things that we're doing. But I expect to see continued investment on Wolfspeed. But again, that's been a little bit gated by the fact that we're taking cost down on the LED side.

Gary Mobley -- Wells Fargo -- Analyst

Okay. For my follow-up question, I want to ask about your relationship with some of your European silicon carbide customers in particular one recently announced full on qualification of some silicon carbide materials from a company they had an investment in and subsequently has taken up the full ownership of the company. So I'm just wondering, looking out a few years from now, how you see splitting the supply there with internal sources versus use a merchant supplier?

Gregg Lowe -- President, Chief Executive Officer, Director

Yeah, so I think you're probably referring to the ST acquisition of Nortel and then their decision to -- I think they initially acquired 55% and then they've decided to pick up the rest of it. I think it's another confirmation that the world of silicon is converting to silicon carbide. The fact that ST is investing in this and thinking through could they do this capability on their own? Would be a very natural thing for anybody to want to do. We've got a great partnership with them. We've got a long-term agreement with them with Infineon with ON semiconductor and with another very large power semiconductor company. And these long-term arrangements are multi-year, we don't talk specifically about any one of them but you can kind of estimate on this sort of half a decade kind of type timeframe. So we've got a very long term arrangement with these folks and what we've seen in terms of the materials business is a couple of things. One is we signed these long-term agreements and there is a certain percentage that the customers want to get BARE wafers and there is a certain percentage that they want to have epi wafer, so it's more added value from CREE on those wafers and that starts out at a certain point. And as the customers get to start utilizing these wafers, the percentage that they want on of epi goes up pretty significantly, and I think it's because they find that silicon carbide, epi on silicon carbide, there are more difficult things to do. I think the kind of capability you need to have to grow high quality silicon carbide. It's a very, very difficult business to get into. I think the fact that these folks are trying to do that as part of their supply is very natural. I think that most companies have found it really, really difficult to end up with very high quality, low cost silicon carbide materials.

And so what we're doing, we've got a substantial scale advantage in silicon carbide materials. We're substantially the number one supplier of silicon carbide wafers and materials in the world and we've announced that we're increasing that capacity by 30 fold. So we -- and you heard earlier, we're doing that through converting LED crystal growers to Wolfspeed and increasing the productivity of what we're getting out of our crystal growers, which takes our cost down. So what we're doing is we are driving this thing as hard as we can to take the cost delta between silicon and silicon carbide and make it smaller. And so folks that are trying to enter this business are going to be chasing us down the cost curve and experience curve that we've got a lot of capability in.

Operator

Our next question comes from Joe Osha with JMP Securities. Your line is now open.

Joe Osha -- JMP Securities

Hi. Yeah, two questions and the first one follows on that previous question, one of the things you want to do, if you want to be a dominant low-cost supplier is you need to make sure your lead times don't get out too far. So I'm just wondering philosophically, obviously you're little underutilized now, but is the idea going to be to sort of have a fab that's booked 12 months out at all time? Or is the idea going to be -- to maybe try and stay a little bit ahead of it even perhaps at the risk of periodically being underutilized in order to avoid a situation where your customers can't get more out of you unless the book 18 months out?

Neill Reynolds -- Chief Financial Officer, Executive Vice President

Hey, Joe. This is Neill. Thanks for the question. The way I think about it is we have obviously a long run here and basically, what we're saying is we're by making the investment in the fab in New York is we're going to put capacity ahead of demand. So I think -- and I think that's important, if you look over cycles, people have done that we can certainly be successful not just internally in terms of driving our output, but in terms of fortifying that capacity with our customer. So I think it's more toward the latter in terms of ensuring that we've got capacity ahead of demand and we're aligned with our customer base and ensuring we've got supply.

Joe Osha -- JMP Securities

Okay. Thank you.

Gregg Lowe -- President, Chief Executive Officer, Director

And recall that fab ramps production in 2022, it hits kind of its where we're currently planning it to be by 2024. So it's quite some time out before we get into a position where we've got that being substantially ramped. I think with the arrangement that we've made with New York and with the Mohawk Valley team in terms of the incentives associated with that fab, we feel very, very comfortable putting that thing in place, so it's going to be a great option for us.

In terms of materials, the good news is that the majority of our business that we do even this quarter is through long-term contracts. So we've got very, very good line of sight in terms of what is going to be needed over the next half a decade. We can translate that into how many cars that would be able to handle and we're very, very comfortable about where that capacity is coming in relative to what could be the low end -- what could be the mid-range and what could be the high end of the demand. Our ability to pivot on materials is a lot -- we're a lot more nimble in terms of being able to ramp up capacity faster. Part of that is because we've got silicon carbide growers used for LED that we can shift over and recall, that's about a two-week type operation. But part of it as well is that silicon carbide manufacturing plant is not a clean room environment, think of it as -- it's obviously a good environment, but it's not a clean room we could build a building, an outfit it to grow more silicon carbide crystals substantially faster than it would take us to start a grounds up wafer fab. So we've got a really good kind of flexibility on that.

Joe Osha -- JMP Securities

Thank you. And then from the highway general to the highway specific. Just wondering on EV powertrains I heard you mentioned 800 volts. I'm just curious where most of the design -- new designs you're seeing come in at this point. Is it 600, 800 volts for the most part.

Gregg Lowe -- President, Chief Executive Officer, Director

I think most of the folks that have product on the road today are 400 and most of the folks that are in design are moving higher to 800 and some are even going higher 1,200 I've seen a couple of 1,200-volt type opportunities. And it's simply -- it's a better more efficient system, it also enables charging.

Operator

Our next question comes from Paul Coster with JPMorgan. Your line is now open.

Paul Coster -- JP Morgan -- Analyst

Yeah. Thanks for taking my question. On the -- when does that Huawei OEM enters into supply arrangement with the MOSFET provider. Is this a self -- do you think it's going to be self-sourced? Is it self-sourced at the device level or is it -- and is it self-sourced through the supply chain? In other words, I mean would be qualify MOSFETs to have alternative substrate suppliers?

Gregg Lowe -- President, Chief Executive Officer, Director

Most of the automotive OEMs desire to have multiple suppliers across our entire supply chain. I think that's the desired outcome. The practicality of it though is a little bit different and that's because there is a very long qualification process. They generally don't start with two and qualify two in parallel. They generally start with one get that one ramped up and then your dedicated toward these systems. And then if they decide that they've got the bandwidth and the wherewithal that qualify the second one they do that. And so I think -- so it's kind of a yes or no answer. Yes they would desire to do that, but from a practical standpoint, a lot of times you find that the first supplier has -- I don't know 70% 80% of the of the business and the second supplier has the rest of it.

Paul Coster -- JP Morgan -- Analyst

Okay. And then three sort of generic question here, but I don't think anyone's going to second guess the magnitude of this more clearly the timing with which the EV market comes together, it's very difficult to pin down and you have a different cycle on your investments you're investing to the multiples of five-year payback, I imagine. I mean, is there a risk here that you're over building capacity too soon. If you are -- what can you do to sort of mitigate the effects on gross margins of low utilization rates if the journey proves to be longer than anticipated?

Gregg Lowe -- President, Chief Executive Officer, Director

Yeah. Well thanks for that question. So let me kind of frame it at a couple of different ways here. So first off in terms of the wafer fab because of the way the incentives work and so forth, we feel like we're going to be in pretty good shape from that perspective, we will be building that wafer fab -- literally we're going to be breaking ground I think in the next couple of weeks and that will ramp in 2022 and we will ramp that sort of wafer fab lines at a time. We won't fill the entire factory at one-time will ramp line based on how much demand we'll have at that time, we'll will ramp second-line based on the demand and so forth. So we can time that pretty, pretty easily. And then, it's the same -- it's not the same thing, it's even more -- we're more nimble on the silicon carbide side of it because we turn on these machines and we're up and running in a couple of weeks' time. So I think we've got an ability to manage that, that being said, there is going to be some ups and downs as we go through that cycle and there is going to be periods of underutilization and periods of demand exceeding our supply and that's going to be pretty normal I think through that cycle.

The additional thing that I would say is, we are able to kind of get a pretty good understanding of our supply and translate that into the percentage of electric vehicles on the road and get a pretty good understanding of -- do we think we're trying to be too far ahead of it or not far enough -- not leaning and often. So I think we have a pretty good understanding of that. But what I would say is, if you take a look at Europe and you look at the adoption of electric vehicles, the current emission standards in Europe are 126 grams of CO2 per kilometer that goes down to 98 grams of CO2 per kilometer in 2021 and it goes down to 75 grams of CO2 per kilometer by 2025 and that's kind of fleet average, if you will.

A typical gasoline engine currently gets approximately 126 grams of CO2 per kilometer, a plug-in hybrid I believe is forecasted to be in sort of the 90-ish range of grams of CO2 per kilometer and a fully electric vehicle has zero. So some part of their fleet is going to be 126 grams per kilometer, some part of the fleet is going to be 90 and the rest of it is going to be zero, and they need to get to 75. So I think the adoption in Europe on electric vehicles is probably going to be relatively fast because the math just you kind of can't get there from here unless you have a sizable increase in the electric vehicle production and sales.

Operator

Our next question comes from Harsh Kumar with Piper Jaffray. Your line is now open.

Harsh Kumar -- Piper Jaffray -- Analyst

Yeah, hi guys. Question on Wolfspeed gross margins. So I think historically, I know there's a lot of moving parts, but historically, I think the high was 50 worth kind of running in the 47, 48. I think you guys are talking about one to two quarters worth of sort of the scrap issue and sort of getting your arms around some of these other things that are temporary. How can we think of the ramp? So is a correct premise to think that in one to two quarters we can expect to be sort of on away up or will you start moving up going forward and then ultimately get to that high 40s after one or two quarters?

Gregg Lowe -- President, Chief Executive Officer, Director

So Harsh, I think the way to think about that is, it'll really depend on the timing of some of the volume certainly the MOFSET yield impact I think we've got -- we got line of sight to that, so we'll see some improvement from that. The materials business like we said, should continue to grow. So I kind of think of that again as a temporary item as you get back to the end of the year, if we still -- if things do kind of stabilize, then we should see some improvement as those things start to resolve. So like as time goes on we'll see some improvement. I just wouldn't expect it dramatically in the short term.

Harsh Kumar -- Piper Jaffray -- Analyst

Okay, fair enough. And then Greg, I think you talked about some Chinese incentives changing to longer range or favoring longer range. Has this already hit and as your exposure today I know your main auto business ramps in 2022 or so? Is today most of your business centered around charges? I just want to clarify.

Gregg Lowe -- President, Chief Executive Officer, Director

Yeah, most of our business right now in China is on the on-board charging and DC to DC conversion. They -- we've got a lot of active developments right now in China around the inverter and that's primarily because of the coming changes in the incentives going toward the longer range vehicles.

Harsh Kumar -- Piper Jaffray -- Analyst

And Greg, has that been announced already or is that kind of something you're picking up from sort of the folks in China?

Gregg Lowe -- President, Chief Executive Officer, Director

And if you're talking about the incentives on the longer-range vehicles, I believe that's officially announced.

Harsh Kumar -- Piper Jaffray -- Analyst

Understood, thank you. And then my last question is on Huawei revenues. I know you're under ban but I think you were able to ship some legacy portions I suspect from the acquired parts of the business. Is that business -- could you give us a size or some color on is that still the case or is Huawei a zero? And then also could you talk about your design portfolio with non-Chinese OEMs on RF side?

Neill Reynolds -- Chief Financial Officer, Executive Vice President

Yeah. Thanks, Harsh. This is Neill. So I think as you look forward, we talked previously about the certain amount of revenue being part of Huawei, but we're not shipping to Huawei right now. So there's really no direct shipments to Huawei. So that's kind of out of the numbers. In terms of the pipeline look there is other opportunities, there's obviously a pause in the 5G kind of roll out right now. We do have other opportunities in the pipeline and that's part of the $9 billion that Gregg talked about and we're actively working now. So as you know, there is other areas outside of China, we'll continue to trying to work on. China is obviously and Huawei is a significant player in the industry, but in the meantime, yeah, we're looking to work on those opportunities.

Operator

Our next question comes from Colin Rusch with Oppenheimer. Your line is now open.

Colin Rusch -- Oppenheimer -- Analyst

Thanks so much guys. As you move toward one of that 8-inch fab in New York. Can you speak to the maturity of the epi process for those 8-inch wafers? Have you chosen an equipment supplier and can you say whether you're planning to use a single wafer or a mini batch tool?

Gregg Lowe -- President, Chief Executive Officer, Director

I don't want to get into a lot of detail. We are obviously working very, very closely with a supplier on epi. We've got a very good partnership with them. I don't want to announce who and when and so forth. So I'll just leave it at that.

Colin Rusch -- Oppenheimer -- Analyst

Okay great. And then as you're looking at the competitive dynamics around 4 and 6-inch wafers relative to the 8-inch wafers. Is it a real concern around folks ramping capacity and trying to drive prices lower for you guys is -- how do you handle that situation as you think about building out capacity and trying to balance that appropriately?

Gregg Lowe -- President, Chief Executive Officer, Director

Let me just kind of make sure we frame things correctly, so 8-inche is quite a ways out.

Colin Rusch -- Oppenheimer -- Analyst

Yeah, OK. Fair enough.

Gregg Lowe -- President, Chief Executive Officer, Director

So we're going to be -- we're ramping right now 6-inch and the crystal growers that we're installing and all this ramp in capacity that we're talking about is 6-inch and it's going to be quite some time. We are building an 8-inch fab, but sort of the thought process is a likelihood of ramping that thing as a 6-inch fab and converting it is the thought process. And it's a lot easier to build an 8-inch fab and start with 6-inch then to build a 6-inch fab and try to convert it to 8-inch and so it's just the practicality of it all.

What I would tell you in terms of competition. We've got a lot of folks that are interested in building silicon carbide crystals and turning them into wafer isn't putting up beyond and all of that kind of stuff. We've got a tremendous amount of experience. We're going to be talking a little bit about this at our Investor Day that's coming up. This is a very, very difficult technology to work with but we respect the fact that we've got competitors that are out there and they're trying to get a piece of this business. The best thing we can do is take the advantage of the opportunity we have from a scale perspective, drive the cost down, drive the productivity up and get more adoption of silicon carbide in the silicon market. And as we do that there'll be more demand for our product. As I mentioned earlier, in terms of near-term, we kind of don't see any near-term issue at all from a pricing because the majority of our business are these long-term contracts. So we don't -- what's happening in the 4-inch market is noise.

Operator

our next question comes from David O'Connor with Exane BNP Paribas. Your line is now open.

David O'Connor -- Exane BNP Paribas -- Analyst

Great. Thanks for taking my questions. Two if I may, maybe firstly Neill going back to what you mentioned earlier on the percentage of epi wafer versus base wafers. And against the backdrop of your long-term gross margin target for Wolfspeed, what is your assumption there for the mix of be it a bear wafers versus epi wafers? That's my first question. And then maybe a second question for Gregg on Huawei at the moment Huawei has been rebuilding some of its RF supply chain in Asia. What is the risk that this GaN PA demands that never actually materializes whether that's true of made-in China policy or just changes in the competitive landscape? Thanks.

Gregg Lowe -- President, Chief Executive Officer, Director

Yeah, so on the first question, we won't give you the split of bear versus epi. We obviously know what that is and we've built that into the plan. And what I would say is, the customers that have begun to ramp with us they like what we're doing from an epi perspective and they're very good customers and we work with them, I must say, well, I'm sure, on a daily basis with supply and demand. But so we've got that understood that, but I don't want to publicly state what that is. I would just say that, the epi demand has been growing in fact, we are constrained right now on epi and we could supply more EPI wafers if we had that capacity. So we're working on ramping up the capacity on epi.

In terms of Huawei, what I would say, is every semiconductor company that is doing business in China has to face the reality that this ban is having an impact on their thought process as it relates to U.S. companies. And of course, we have great relationships with these customers. We work with them on an ongoing basis. We've got technology that we think is better. But I think anybody that's doing business in China has to realize that it probably -- you're going to need to be even better to continue doing business over there because of the concern that they -- I would imagine that they have about these entity lists and bans and trade conflict and so forth.

Obviously at some point, there is going to be some agreement between the two company -- countries. I have no clue when that is, because it just seems like every other week there is a positive trend and then the other week, it goes completely opposite direction, so we just have to be nimble in the meantime and do the best we can to stay engaged.

Operator

Our next question comes from Jeff Osborne with Cowen. Your line is now open.

Jeff Osborne -- Cowen and Company

Yeah. Good evening, guys. Just a couple on my end. I was wondering on the scrap issue is that a new skew or product that you are making or new machines, any detail that you could provide would be helpful. And sort of a second derivative of that line of questioning, is there any risk to sort of auto qualifications that were in the queue because of the delays there?

Gregg Lowe -- President, Chief Executive Officer, Director

It's a change from a 100-millimeter wafer size to 150. It really isn't related to that change itself but we're ramping that in our Durham factory. We know exactly what the problem is. We've got that pretty clearly identified. We've got the changes in place. And so that is -- those changes are being implemented, like I said, as we speak. We're getting results out on that. In terms of qualification what it's doing is it's limiting the amount of product that we can get out because of yields are less than we would anticipate. I think we're just simply a manufacturing cycle away from that and so you just -- we're going to see this kind of wave of less than optimal yields coming out of the factory. And then as we implement these improvements, we'll see the yield go back up and qualifications staying on track.

Jeff Osborne -- Cowen and Company

Got it. That's helpful. Just a few other quick ones here. Neill, how do we think about with all the changes in the LED segment and the headwinds -- how do we think about the gross margins trajectory from here which is all the reallocation of equipment. Should we think about staying at this 20% level, I think in the past you've talked about like 10 points higher as a goal but looks to be maybe a stretch?

Gregg Lowe -- President, Chief Executive Officer, Director

Yeah, look, I think the LED business has been impacted by lower revenue and we've had -- we took utilization down to support that that's impacted the margins. As I said earlier, we kind of see that kind of stabilized and kind of flattish as time goes on here. So I'd kind of expect the same as we move forward. We might see a little bit of movement. We're seeing some pick up here in 2Q, just based on some licensing revenue as a mix, so you may see some improvement based on that. And as we move to the outsourcing margin, we may get some pickup as well. But as of right now kind of flattish maybe a little bit this kind of probably the best way to think about it.

Operator

Our next question comes from the line of Ambrish Srivastava with BMO Capital Markets. Your line is now open.

Ambrish Srivastava -- BMO Capital Markets.

Hi. Thank you very much. Neill, I think it would be helpful and I apologize if I missed this. Could you give us a breakdown -- quantify the breakdown on the gross margin side from the two items that you've mentioned. And then as we think through, if I recall correctly, mix was an issue from June to September as well, so that based on what you -- how you've answered these questions that should not come back because Huawei is out of the numbers and that is a higher margin product. So what's the right way to think about the quantification of the impact, the bridge between what you delivered and what you're guiding to. And then sounds like the scrap yield issue would reverse in a couple of quarters, but what about the other impacts? Thank you.

Neill Reynolds -- Chief Financial Officer, Executive Vice President

Thanks, Ambrish. Yeah, so couple of things. So breaking that down in terms of the gross margin for Wolfspeed, so going from 4Q to 1Q, we had some mix issues. I think that's already baked in. As you think about the two items that are impacting us going into 2Q. It was the yield and the utilization in the materials factory, and those to the utilization, I'd say is the majority of the issue. And then to a lesser extent, the yield in the scrap issues. But both of them are probably going to follow similar type of time, it'll a little bit of a cycle I think in both events on a yield issue like this, you got to get the implement the improvements and then run it through manufacturing cycle and then utilization once you start to ramp the factory again it takes another kind of inventory cycle to kind of get things improved again. So that could take one to two quarters. So I think you could think of both of them kind of taking the same type of timeframe to improve.

Ambrish Srivastava -- BMO Capital Markets.

Okay. And then for my follow Gregg comps is notoriously lumpy. With 5G your -- what you're seeing is outside of Huawei, right. And then are there any specific geos that you're seeing the push outs that you were designed that's impacting the business?

Gregg Lowe -- President, Chief Executive Officer, Director

Yeah, I mean I would say that a lot of folks we're anticipating picking up a lot of business from them and that doesn't seem to have happened. And so I think -- and then additionally 5G itself as the ramp has slowed. So I think it's just a general trend right now, what I would say, is 5G is going to happen and because the data demands are just there. But with this, the demand happening with Huawei it isn't throwing the impact I think on the others that one would have anticipated.

Operator

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

Gregg Lowe -- President, Chief Executive Officer, Director

Well, thanks everybody for your interest in Cree. Our strategic transformation remains on track and we're extremely excited about the long-term prospects for our business and the adoption of silicon carbide. We hope to see you at our Investor Day in New York on Wednesday, November 20th at the Grand Hyatt Hotel. Thanks again and have a great day.

Operator

[Operator Closing Remarks]

Duration: 63 minutes

Call participants:

Tyler Gronbach -- Vice President, Investor Relations

Gregg Lowe -- President, Chief Executive Officer, Director

Neill Reynolds -- Chief Financial Officer, Executive Vice President

Brian Lee -- Goldman Sachs -- Analyst

Jed Dorsheimer -- Canaccord Genuity -- Analyst

Craig Irwin -- ROTH Capital Partners -- Analyst

Gary Mobley -- Wells Fargo -- Analyst

Joe Osha -- JMP Securities

Paul Coster -- JP Morgan -- Analyst

Harsh Kumar -- Piper Jaffray -- Analyst

Colin Rusch -- Oppenheimer -- Analyst

David O'Connor -- Exane BNP Paribas -- Analyst

Jeff Osborne -- Cowen and Company

Ambrish Srivastava -- BMO Capital Markets.

More CREE analysis

All earnings call transcripts

AlphaStreet Logo