Business context and reporting period
This is Cree, Inc.’s Form 10-K for the fiscal year ended June 26, 2016—not a standalone Wolfspeed filing or a filing for fiscal 2015 Q4. Cree reported Lighting Products, LED Products, and Power and RF Products segments. After year-end, Cree agreed to sell its Power and RF Products segment and certain related SiC materials assets, collectively the Wolfspeed business, to Infineon.
Financial results and liquidity
- Revenue: $1.617 billion, down 1% from $1.633 billion in fiscal 2015.
- Profitability: Gross profit was $487.1 million and gross margin was 30%, versus $473.9 million and 29% in 2015. Operating loss narrowed to $10.5 million from $73.6 million; net loss narrowed to $21.5 million from $64.7 million. Diluted loss per share was $0.21, compared with $0.57.
- Cash flow and investment: Operating cash flow was $203.3 million, up from $181.3 million. Capital expenditures were $120.0 million, down from $206.2 million. Cash used in financing was $167.9 million, including $149.6 million of share repurchases.
- Liquidity: Cash, cash equivalents and short-term investments totaled $605.3 million, down from $713.2 million. Working capital was $933.7 million, versus $1.053 billion. Inventory rose to $303.5 million from $280.6 million; the cash conversion cycle lengthened to 94 days from 79.
- Debt: Long-term borrowings under the $500 million revolving credit facility were $160 million, down from $200 million; $340 million remained available. The company reported compliance with loan covenants.
Material changes versus fiscal 2015
- Lighting Products revenue fell 2% to $889.1 million; gross margin improved to 27% from 26%, helped by product mix and factory cost reductions. Unit volume declined 22%, while average selling price rose 26%.
- LED Products revenue increased 1% to $610.8 million, partly due to new patent-license revenue. Unit volume rose 12%, but average selling price fell 11%; gross margin improved to 35% from 32%.
- Power and RF revenue declined 6% to $116.7 million, primarily because RF unit volume fell. Gross margin declined to 48% from 55%, reflecting new-product ramp costs and mix.
- Fiscal 2016 included $18.8 million of LED restructuring charges; the restructuring concluded in the second quarter. Fiscal 2015 had $47.7 million of losses on disposal or impairment of long-lived assets, compared with $16.9 million in 2016.
- Fiscal 2016 net loss included a $15.4 million loss on the Lextar investment and $4.5 million of net foreign-currency losses. The effective tax rate was 8%, versus 23% in 2015, with a foreign-tax-asset valuation allowance affecting the tax benefit.
Outlook, commentary, risks and unusual items
- Management expected commercial LED lighting markets to expand in fiscal 2017, while consumer LED bulbs and LED components would remain highly competitive. Stated priorities included growing revenue, improving operating margin, controlling operating-expense growth, and improving product and service performance. No specific consolidated revenue or earnings guidance was provided in the cited outlook.
- On July 13, 2016, Cree agreed to sell the Wolfspeed business to Infineon for $850 million cash, subject to adjustments and closing conditions, with closing expected by calendar year-end 2016. Cree expected the divestiture to reduce short-term profits while increasing free cash flow and management focus. The company expected to report the business as discontinued operations beginning in fiscal 2017. Regulatory approvals, including U.S. antitrust and CFIUS approvals, were required; certain regulatory-related terminations could trigger a $12.5–$42.5 million fee payable by Infineon.
- Transaction terms include a five-year non-compete, transition services, a temporary wafer-supply arrangement, and Cree indemnification for certain liabilities. Cree would retain certain pre-closing liabilities.
- Key risks include persistent LED price pressure and rapid technology change, demand and capacity mismatches, customer and distributor concentration, supply constraints, foreign-exchange exposure, warranty claims, litigation, and execution or failure of the Wolfspeed sale. One customer, Arrow Electronics, represented 10% of fiscal 2016 revenue.
- The company voluntarily recalled certain linear LED T8 replacement lamps in 2015 due to overheating and melting; it expected insurance to cover most costs, with an immaterial financial impact. Warranty liabilities were $21.5 million at year-end, up from $14.0 million.
- Cree revised prior-period financial statements for an immaterial patent-amortization error; the filing states the corrections did not affect operating cash flow. The auditor gave an unqualified opinion and concluded internal control over financial reporting was effective.
Important facts for investors to verify
- Whether the Infineon transaction closed, its final adjusted proceeds, and any retained liabilities, indemnities, or transition costs.
- Whether commercial-lighting growth and margin improvements offset continuing pricing pressure in consumer bulbs and LED components.
- Inventory quality, channel inventory and reserves, and progress in reducing the 94-day cash conversion cycle.
- The outlook for Lextar investment value, foreign-currency exposure, and tax valuation allowances.
- Potential warranty and recall costs, litigation exposure, and the availability and terms of the revolving credit facility.