Business context and reporting period
Cree, Inc. (now identified with Wolfspeed in the request metadata) filed this unaudited Form 10-Q for the quarter ended December 29, 2019, the second quarter of fiscal 2020. The company reported two continuing segments: Wolfspeed, covering silicon carbide and GaN materials, power and RF devices; and LED Products. Its Lighting Products business was sold to IDEAL Industries in May 2019 and is reported as discontinued operations.
Financial performance
Amounts are in millions of U.S. dollars except per-share data. Comparisons are with the corresponding prior-year period unless otherwise noted.
| Metric | Quarter ended Dec. 29, 2019 | Six months ended Dec. 29, 2019 |
|---|---|---|
| Revenue | $239.9, down 14% | $482.7, down 13% |
| Gross profit / margin | $61.9 / 25.8% (prior: $103.5 / 36.9%) | $136.1 / 28.2% (prior: $201.8 / 36.4%) |
| Operating income (loss) | ($56.4) (prior: $10.0) | ($95.3) (prior: $20.8) |
| Net loss attributable to controlling interest | ($52.8); diluted loss per share: $0.49 | ($90.6); diluted loss per share: $0.84 |
| Operating cash flow | Quarterly figure not provided in the filing text | ($11.8) from continuing operations (prior: $109.8) |
- Wolfspeed quarterly revenue was $120.7, down 11%; segment gross margin fell to 34.6% from 47.8%. Six-month revenue was $248.4, down 5%, and margin was 40.6% versus 47.6%.
- LED Products quarterly revenue was $119.2, down 18%; segment gross margin was 22.2% versus 30.0%. Six-month revenue was $234.3, down 20%, and margin was 20.7% versus 29.0%.
- At December 29, cash and cash equivalents were $382.6 and short-term investments were $568.9, totaling $951.5, down from $1,051.4 at June 30, 2019. Current assets were $1,292.6 and current liabilities were $248.5.
- Convertible notes had $575.0 principal outstanding and a $480.5 net carrying value; they bear 0.875% interest and mature September 2023. The $250.0 revolving credit facility had no borrowings and was available in full; the company reported covenant compliance.
- Six-month capital expenditures were $101.0, versus $63.2 a year earlier. Cash used in investing activities was $120.5 and cash provided by financing activities was $14.5.
Material changes and management commentary
- Management attributed Wolfspeed revenue weakness to softer Power and RF demand and the U.S.-China trade dispute. In the quarter, higher average selling prices from product mix were offset by a 16% decline in units sold.
- LED Products revenue declined amid a global LED demand pause; quarterly unit volume fell 8% and average selling price fell 11%. Lower demand and factory underutilization also pressured LED margins.
- Wolfspeed margin pressure reflected higher product costs, lower yields, product mix, and inventory reserves related to Huawei. Management disclosed an $8.3 inventory reserve for Huawei products in the second quarter.
- Research and development expense rose 18% for the quarter and 19% for the six-month period, primarily reflecting continued investment in silicon carbide and GaN. Other operating expense increased to $13.8 for the quarter, including project, transformation and transaction costs, factory start-up costs, and restructuring.
- Non-operating results included a $6.4 quarterly gain on the Lextar equity investment, reflecting an increase in its share price. The investment is subject to market volatility.
- Cash used in continuing operations for the six months contrasted with $109.8 provided in the prior-year period. The filing cites lower earnings and working-capital movements, including incentive payouts and changes in inventory and payables.
Outlook, risks and contingencies
- Management targeted approximately $230.0 of fiscal 2020 capital investment, mainly for infrastructure supporting long-term growth. It stated that working capital, the credit facility and anticipated operating cash flows should cover operating needs and capital expenditures for at least 12 months.
- The company is expanding silicon carbide and GaN manufacturing capacity, including a planned automated, 200mm-capable facility and materials factory in Durham, North Carolina, and announced an intended facility in Marcy, New York. It expected approximately $70.0 of factory-optimization restructuring charges through 2024; the Marcy decision’s effect on future charges was still under evaluation.
- Management identified trade restrictions and tariffs, including restrictions on Huawei shipments, as risks to revenue and inventory. The filing also cited a coronavirus outbreak in China as a potential operational and economic risk.
- Other stated risks include demand and pricing cycles, production yields and capacity utilization, execution of manufacturing expansion, customer and supplier concentration, competition, and volatility in the Lextar investment. Results may also be affected by tax valuation allowances; the company maintained a full valuation allowance against U.S. and Luxembourg deferred tax assets.
- Various legal proceedings were ongoing. Management said outcomes were not reasonably estimable and that an unfavorable result could materially affect the business, although it did not then expect the proceedings to materially harm the company overall.
Important facts for investors to verify
- Whether demand, shipment volumes and margins in both segments recover, and how much of the recent decline reflects market conditions versus company-specific execution.
- The amount and future implications of Huawei-related inventory exposure, trade restrictions and the $8.3 reserve.
- Progress, timing, funding and expected returns for the capacity expansion and fiscal 2020 capital spending target, including the Marcy facility decision and projected restructuring charges.
- Operating cash generation and liquidity as investment and capital-expenditure needs continue; also monitor the $575.0 note principal, conversion terms and credit-facility covenants.
- Future changes in the Lextar investment’s fair value, the earnout and retained obligations from the Lighting Products sale, and any material developments in litigation or tax matters.