Business context and reporting period
This is Cree, Inc.’s unaudited Form 10-Q for the three months ended September 27, 2020—its fiscal 2021 first quarter, not calendar-year 2020 Q1. Cree operated two reportable segments: Wolfspeed (silicon carbide, gallium nitride, power and RF products) and LED Products. The filing was signed October 29, 2020. The company’s later name and ticker are not reflected here; the filing identifies Cree, Inc. and ticker CREE.
Financial results and liquidity
| Metric | Quarter ended Sept. 27, 2020 | Prior comparable quarter |
|---|---|---|
| Revenue | $216.6 million | $242.8 million |
| Gross profit / margin | $54.0 million / 24.9% | $74.2 million / 30.6% |
| Operating loss | $170.0 million | $38.9 million |
| Net loss attributable to controlling interest | $184.4 million | $37.8 million |
| Diluted loss per share | $1.68 | $0.35 |
| Cash provided by (used in) operations | $0.4 million | ($20.0 million) |
| Purchases of property and equipment | $114.0 million | $42.0 million |
Cash, cash equivalents and short-term investments totaled $1,138.5 million at quarter-end, down from $1,251.7 million at June 28, 2020. Current assets were $1,485.3 million and current liabilities $343.4 million. Convertible notes had a $793.6 million net carrying value and $999.8 million principal outstanding. The $125 million revolving credit facility was undrawn and fully available. Cash and cash equivalents alone were $436.4 million. Investing activities used $16.0 million; financing activities provided $3.1 million; cash and cash equivalents decreased $12.4 million.
Segment performance
| Segment | Revenue | Gross profit | Gross margin |
|---|---|---|---|
| Wolfspeed | $115.5 million, down 10% | $42.3 million, down 28% | 36.6%, versus 46.2% |
| LED Products | $101.1 million, down 12% | $22.4 million, versus $22.1 million | 22.2%, versus 19.2% |
Consolidated gross profit includes $10.7 million of unallocated costs, up from $6.9 million. The filing cites COVID-related manufacturing costs and underutilization associated with transitioning certain LED operations to Wolfspeed.
Material changes and unusual items
- Revenue declined 11% year over year. Management attributed the Wolfspeed decline to COVID-related supply and demand factors, U.S.-China trade tensions and shipment timing; LED revenue was affected by weaker COVID-related demand and factory capacity restrictions.
- Gross margin fell 5.7 percentage points. Management cited higher Wolfspeed costs, customer mix and lower revenue; LED margin improved with more favorable product and customer mix.
- A $105.7 million goodwill impairment was recorded against LED Products after Cree concluded it was more likely than not that it would sell all or part of the segment below carrying value. This non-cash charge was a major driver of the larger operating and net losses; it was not tax-deductible.
- Non-operating expense was $14.0 million, compared with $1.6 million of income in the prior-year quarter, reflecting higher interest expense, lower interest income and a $3.4 million loss on the Lextar equity investment.
- Other operating expense rose to $13.4 million, including $4.8 million of restructuring costs, $5.6 million of project, transformation and transaction costs, and $3.0 million of factory start-up costs.
- Capital spending increased to $114.0 million. Accrued property and equipment was $108.2 million at quarter-end, versus $8.8 million a year earlier.
Outlook, management commentary and risks
Management gave no specific quarterly revenue or earnings guidance in the provided filing text. It targeted approximately $400 million of net capital investment for fiscal 2021, dependent on construction timing and progress. Cree expects to invest approximately $1.0 billion through fiscal 2024 in its new Marcy, New York silicon carbide facility; approximately $500 million is expected to be reimbursed through a New York State grant, subject to grant requirements. Management said current liquidity and expected operating cash flows should cover operating needs and capital expenditures for at least 12 months, while warning that COVID-19’s effects remain uncertain.
On October 18, 2020, after quarter-end, Cree agreed to sell its LED Business to SMART Global Holdings for consideration described as up to $300 million: $50 million cash, a $125 million unsecured promissory note, and a possible earn-out of up to $125 million in another unsecured note, plus assumption of certain liabilities. The transaction was targeted to close in the first calendar quarter of 2021, subject to approvals and other conditions. The earn-out is contingent, the notes are unsecured, and the agreement includes ongoing wafer supply, fabrication and transition arrangements. After completion, Cree expected to operate solely in Wolfspeed.
Key risks discussed include the uncertain impacts of COVID-19 on demand, workforce, suppliers and production; trade restrictions and tariffs, including restrictions affecting Huawei; competitive pricing and product adoption; manufacturing yields and capacity-ramp execution; execution and financing risks related to the New York facility; and the risks of completing the LED divestiture and collecting its deferred and contingent consideration. Litigation outcomes were not reasonably estimable; management did not believe the proceedings were expected to materially harm the company, but noted adverse outcomes could have a material effect. The company reported effective disclosure controls and no material change to internal control over financial reporting during the quarter.
Most important facts for investors to verify
- Confirm the correct issuer and period: this filing is Cree, Inc.’s fiscal 2021 Q1 report, though the request identifies Wolfspeed, Inc. and 2020 Q1.
- Assess how much of the $184.4 million attributable loss reflects the $105.7 million goodwill impairment and other restructuring, transaction and start-up costs, versus ongoing operating performance.
- Track whether Wolfspeed revenue and gross margin recover, and whether the planned capacity expansion improves yields and utilization as expected.
- Verify the LED divestiture’s closing, final adjustments, SMART’s ability to pay the $125 million note, and whether any earn-out is achieved and collected.
- Monitor cash burn, capital spending, New York grant reimbursements and compliance with the grant’s employment, investment and fee requirements.
- Review convertible-note repayment, conversion and dilution terms, along with the company’s ability to service the debt through its operating cash flows.