Business context and reporting period
This filing is Cree, Inc.’s Form 10-K for the fiscal year ended June 30, 2019 (a 53-week year), not a 2018 Q4 filing for a company named Wolfspeed. Wolfspeed is one of Cree’s two continuing reportable segments; the other is LED Products. The filing reports annual results and includes FY2019 fourth-quarter figures.
Cree develops silicon carbide (SiC) and gallium nitride (GaN) materials and power/RF devices, along with LED chips and components. It sold its Lighting Products business unit to IDEAL Industries on May 13, 2019 and reports that unit as discontinued operations. The fiscal-year comparison includes a full year of the Infineon RF Power business acquired in March 2018.
Financial results and key metrics
| Metric | FY2019 | FY2018 |
|---|---|---|
| Revenue | $1,080.0 million | $924.9 million |
| Gross profit / margin | $391.0 million / 36.2% | $302.0 million / 32.7% |
| Operating loss, continuing operations | $15.9 million | $28.0 million |
| Net loss, continuing operations | $57.9 million | $16.4 million |
| Net loss from discontinued operations | $317.2 million | $263.5 million |
| Total net loss | $375.1 million | $279.9 million |
| Diluted loss per share, continuing operations | $0.56 | $0.17 |
| Cash from operating activities | $202.3 million | $173.5 million |
| Capital expenditures | $142.4 million | $185.7 million |
- Revenue mix: Wolfspeed revenue rose 64% to $538.2 million, driven by organic growth, the acquired RF business, and higher average selling prices. LED Products revenue fell 9% to $541.8 million amid lower unit sales and pricing.
- Margins: Wolfspeed gross margin held at 48%; LED Products gross margin improved to 28% from 26%. Consolidated margin increased primarily with higher revenue and segment mix.
- Cash and liquidity: Cash, cash equivalents, and short-term investments totaled $1,051.4 million, up from $387.1 million. Working capital was $1,144.6 million. Cash increased in part from the convertible-note issuance and $219.0 million of net proceeds from the Lighting Products sale.
- Debt: Cree issued $575.0 million of 0.875% convertible senior notes due September 2023; their balance-sheet carrying value was $469.1 million. The $500.0 million revolving facility had no borrowings outstanding at year-end; $324.2 million was available for borrowing.
- FY2019 fourth quarter: Revenue was $251.2 million; continuing-operations net loss was $34.6 million; discontinued-operations net loss was $99.2 million.
Material changes versus the prior comparable period
- Revenue increased 17% year over year, while continuing-operations net loss widened to $57.9 million from $16.4 million. Higher operating costs, $29.3 million of non-operating expense (including a $16.2 million loss on the Lextar investment and $12.0 million of net interest expense), and $12.7 million of income tax expense contributed.
- Total net loss increased to $375.1 million, largely reflecting discontinued-operations losses, including a $66.2 million loss on the Lighting Products sale and $90.3 million of goodwill impairment. FY2018 discontinued results included $247.5 million of goodwill impairment.
- Cash from operations increased by $28.8 million. Property and equipment purchases declined by $43.3 million, while cash and short-term investments rose substantially.
- Arrow Electronics accounted for 19% of revenue, down from 21% in FY2018 and 24% in FY2017. Distributor sales represented 53% of FY2019 revenue.
Outlook, commentary, risks, and unusual items
- Management’s priorities are to expand Wolfspeed capacity and technology, focus LED Products on differentiated applications, and improve customer service. Cree targeted approximately $198 million of FY2020 capital investment, mainly for Wolfspeed capacity and infrastructure.
- In May 2019, Cree began a multi-year factory optimization plan tied to a new automated, 200mm-capable SiC/GaN fabrication facility and a large materials factory. It expects approximately $70 million of restructuring charges through 2024.
- The Lighting Products sale generated $219 million in net cash proceeds, subject to adjustments, and includes a potential performance-based earnout. Cree also has transition-service obligations and agreed to supply IDEAL with certain LED products for three years.
- Cree suspended shipments to Huawei after U.S. export restrictions took effect in May 2019. Management reported near-term revenue and profit impacts and increased inventory intended for Huawei; the duration and broader effects of restrictions are uncertain.
- Other material risks include competitive pricing and LED market overcapacity, execution and yield risks in capacity expansion and substrate conversion, reliance on limited-source suppliers, customer and distributor concentration, tariffs and international trade restrictions, and litigation. Management said pending legal outcomes were not reasonably estimable, but did not believe the matters would presently materially harm financial position, cash flows, or operating trends.
- The independent auditor gave unqualified opinions on the financial statements and internal control over financial reporting. Its critical audit matter concerned management’s estimates for distributor ship-and-debit and price-protection reserves.
Important facts for investors to verify
- Confirm the correct issuer and period: the supplied filing is Cree, Inc.’s FY2019 10-K, rather than a Wolfspeed FY2018 Q4 filing.
- Assess how much Wolfspeed’s growth reflects organic demand versus the acquired RF business and product mix, and whether the reported margin improvement is sustainable.
- Review the Lighting Products sale accounting, retained liabilities, transition costs, and likelihood and terms of any earnout payment.
- Track the effect of Huawei restrictions and tariffs on sales, inventory, margins, and customer demand.
- Evaluate the $198 million FY2020 capital-investment target and multi-year factory plan against cash generation, execution milestones, and expected restructuring costs.
- Examine distributor reserves and channel inventory, especially given the auditor’s critical audit matter and the increase in inventory days to 104 from 76.
- Monitor the convertible notes’ dilution and repayment exposure, available borrowing capacity, and the valuation sensitivity of Cree’s Lextar investment.