WOLF - Wolfspeed: Accounting Change Spooks Investors But The Story Hasn't Changed

2023-08-18 05:43:52 ET

Summary

• Wolfspeed's outlook remained unchanged, but an accounting change spooked investors.
• Ramping up production at Mohawk Valley remains the #1 issue surrounding the company in the near to medium term.
• Despite its issues, WOLF remains one of the best ways to play the growth in Silicon Carbide.

Back in March I was apprehensive of Wolfspeed ( WOLF ), noting an expensive stock, increased competition, and a lot of CapEx in front of the firm to ramp up production. The stock is down about -30% since that initial write-up. I was more bullish back in May , upgrading the stock to "Buy," thinking the company had kitchen-sinked its FY24 guidance. The stock is at around the same price since that article after its post-earnings sell-off. Let's catch up on the name.

Company Profile

As a refresher, WOLF designs and manufactures semiconductors that use Silicon Carbide (SiC) and gallium nitride (GaN) for power and radio-frequency applications, respectively. The company also makes related SiC and GaN materials.

Its SiC power devices are used in the electric vehicle and solar industries, as SiC has superior thermal conductivity and higher energy efficiency compared to traditional silicon. Its GaN RF devices, meanwhile, help improve efficiency, bandwidth and frequency of operations, and are frequently used in telecom infrastructure, military, and commercial applications.

Fiscal Q4 Results

For the quarter, the company reported a 3% increase in revenue from $188.0 million a year ago to $235.8 million. Analysts were looking for revenue of $222.7 million. The company credited the revenue beat to favorable timing related to product shipments out of its Durham production facilities.

WOLF recorded adjusted EPS of -42 cents, missing the consensus by 22 cents. Adjusted earnings were a loss of -21 cents the prior-year period.

Gross margins came in at 30.3%, a -310 basis point decline. Adjusted gross margins, which exclude stock comp, were 32.6%, down -300 basis points. Gross margins were negatively impacted by higher costs and higher automotive mix for customers that were originally expected to be produced out of its Mohawk Valley facility.

WOLF had -$51.9 million in operating cash flow in the quarter. Free cash flow was an outflow of -$454.8 million. It ended the quarter with $3.1 billion in cash and short-term investments. It had $3.0 billion in convertible notes and $1.15 billion in other long-term debt.

The company had $1.6 billion of design-in wins in the quarter. The company has $8.3 billion of design-ins this fiscal year and over $19 billion since fiscal 2020. Among its flagship customers are design-in wins with Jaguar and Land Rover, Mercedes, BorgWarner and Zeta.

WOLF's quarterly results were fine, with a slight revenue beat and continued strong design-in wins. Margins remain an issue due to the ramp-up issues at Mohawk Valley, which will take a while to get going, and will look worse going forward due to an accounting change. As such, scaling Mohawk Valley will continue to be the most important part of the WOLF story in the short to medium term.

Outlook

For fiscal Q1 2024, WOLF guided for revenue of between $220-$240 million. The guidance assumes revenue of $100 million its Durham facility. The main driver of future revenue growth will be the ramp up of production at Mohawk Valley.

WOLF sees gross margins to fall between 10-18%. Gross margins will take a big hit going forward as WOLF will no longer categorize start-up costs associated with Mohawk Valley as other expenses, and instead any underutilization costs as the facility ramps up will go into cost of goods sold. For Q1, the company expects to see -$37 million, or -1,600 basis points, of underutilization costs. The change in presentation was driven by the SEC as the Mohawk Valley facility is no longer a preproduction facility.

It forecast a loss of between -$1.16 to -$1.35 per share. On an adjusted basis, which excludes stock comp and other items, it guided for an adjusted loss of between -60 to -75 cents.

For the entire fiscal 2024, the company continues to project revenue of between $1-$1.1 billion. It is expecting to spend $2 billion of CapEx.

Discussing the revenue cadence expected to come out of the Mohawk Valley facility on its FQ4 earnings call , CFO Neill Reynolds said:

As you think about utilization, that's the time frame from the time you actually load the wafers into the fab from a utilization perspective until you freeze the wafers, put them to the back end and finally shipping to the customer. So somewhat of a delay you'd expect from the time to achieve utilization level. So, as we get the 20% towards the end of the year, you wouldn't expect to see the revenue translation of that, as we get a 20% utilization, say, by the June quarter, we wouldn't expect a revenue translation of EPI, the equivalent of $100 million to be sometime after that sometime in the second half of calendar '24. So, first half of calendar fiscal '25 as you think about that time frame. So, the sort of timing of the revenue and of the Fab is we did about $1 million or so last quarter. We'll see a bit of a tick up here in Q1, a modest pickup, I think, again, in 2Q and then a steeper ramp as you get to the back half of the fiscal year into the March and June quarter, and then we should be on our way from there."

The company said it has three products that are currently fully qualified with 200-millimeter wafers, and another eight that have now passed all reliability testing. As such, it expects the facility to see 20% utilization by the June quarter.

At the end of the day, the accounting change by WOLF about how it presents its gross margin numbers doesn't change anything about the underlying business. The company needs to ramp up Mohawk Valley, and until it does it will be a big drag on the bottom line, whether those costs show up in COGS or other expenses, or whether they are taken out of adjusted results, or left in. What it does show, however, is how much some investors care about perception, even when they know the reality is different.

Valuation

Re-calculating my prior work, if WOLF can generate $4 billion in revenue at 45% gross margin in 2027, it would generate $1.8 billion in gross profits. Adding back $4.5 billion future CapEx spending to its EV, that would put it at 6.9x FY27 gross profits. Estimating out expenses minus D&A ($650 million), maybe it can do $850 million in FY27 EBITDA, so it's trading at about 14.5x FY27 EBITDA.

The company for its part had been looking for even more margin expansion and lower operating expenses to get to 45% adjusted EBITDA margins. That would put its valuation at 6.9x EBITDA, which would be fairly attractive.

Of course, outer-year projections are already tricky, and WOLF's execution hasn't exactly been good recently and it won't come close to its original FY24 projections from its Analyst Day .

Conclusion

Not much has actually changed with WOLF's results, guidance, or expectations when it plans to ramp up its production at Mohawk Valley. However, investors did not like being hit with the reality that the costs of ramping the facility are real costs.

How WOLF bridges the gap from teen gross margins to the future 45% EBITDA margins it projected at its 2022 analyst day also likely need more scrutiny. Nvidia ( NVDA ) doesn't even have EBITDA margins that high, and its gross margins are around 65%.

That said, the SiC opportunity does look real, and WOLF is one of the better ways to play the trend, along with Aehr ( AEHR ), which I recently wrote about . There also does still appear to be room with FY24 guidance for WOLF to overachieve if it can get Mohawk Valley going. As such, with the stock at the same place where I upgraded it and guidance unchanged, I see no reason to change my "Buy" rating at this time.

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