Cree, Inc. 10-Q Summary — Quarter Ended September 25, 2016
Filing identity: The filing is for Cree, Inc. (fiscal 2017 first quarter), not a standalone Wolfspeed, Inc. filing. Cree had agreed to sell its Wolfspeed business, which it classified as discontinued operations.
Business context and reporting period
Cree reported results for the three months ended September 25, 2016, compared with the three months ended September 27, 2015. Continuing operations consisted of Lighting Products and LED Products. The Wolfspeed business, including power and RF products and certain SiC materials activities, is presented as discontinued operations for both periods.
Financial performance and liquidity
| Metric | Quarter ended Sep. 25, 2016 | Comparable 2015 quarter |
|---|---|---|
| Revenue | $321.3 million | $381.5 million |
| Gross profit / margin | $86.3 million / 26.9% | $107.2 million / 28.1% |
| Operating loss | $10.1 million | $11.7 million |
| Continuing-operations loss | $2.9 million | $25.7 million |
| Net income (loss), including discontinued operations | $0.6 million | $(24.5) million |
| Diluted EPS | $0.00 | $(0.24) |
| Cash provided by operating activities | $18.1 million | $46.8 million |
Lighting Products revenue fell 26% to $183.8 million, mainly on lower commercial fixture sales and a 25% decline in average selling price; its gross margin decreased to 26.8% from 27.9%. LED Products revenue rose 3% to $137.5 million, while its gross margin declined to 30.4% from 31.4%. Total revenue and gross profit exclude Wolfspeed, which was reported separately.
Cash, cash equivalents and short-term investments totaled $589.0 million at quarter-end, versus $605.3 million at June 26, 2016. Cash and cash equivalents alone were $127.8 million. Cash and cash equivalents decreased $38.3 million during the quarter. Capital expenditures were $19.3 million. Inventory was $291.5 million, up from $281.7 million; the cash conversion cycle lengthened to 109 days from 94 days.
Long-term debt was $187 million under a $500 million secured revolving credit facility, with $313 million available. The company reported compliance with its covenants. Current assets were $1.523 billion and current liabilities were $210.9 million; current assets include assets held for sale.
Material changes and unusual items
- Revenue declined 16% year over year, driven by Lighting Products; LED Products partly offset the decrease. Gross margin fell 1.2 percentage points.
- Net income was modestly positive despite a continuing-operations loss, principally because discontinued operations contributed $3.4 million after tax. Wolfspeed reported $49.9 million of revenue and $3.4 million of after-tax income, compared with $43.9 million and $1.2 million, respectively, in the prior-year quarter.
- Non-operating expense was nearly break-even, versus $22.8 million of expense in the prior-year quarter, primarily because the Lextar equity-investment loss was $2.5 million versus $19.9 million. The filing warns that further Lextar share-price declines could materially hurt results.
- Operating cash flow declined 61% year over year, which management attributed primarily to working-capital changes. The cash conversion cycle increased as days of inventory and days sales outstanding rose.
- The company revised prior-period financial statements for an amortization error involving patent useful lives. It said the errors were not material to prior periods individually or in aggregate, but revised the presented 2015 quarter: the revision increased its reported net loss by $0.9 million and reduced EPS by $0.01. The revision did not affect operating cash flow.
Outlook, transaction, and risks
Cree agreed on July 13, 2016 to sell the Wolfspeed business to Infineon for $850 million in cash, subject to adjustments. Closing was expected by the end of calendar 2016, subject to regulatory approvals and other conditions; the transaction had not closed as of the filing. Infineon was expected to hire most of approximately 564 Wolfspeed employees. Cree expected the divestiture to reduce short-term profits but increase free cash flow, sharpen focus on LED lighting, and provide resources for growth. It also anticipated using proceeds and expected cash flow for potential acquisitions and additional repurchases.
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 completing the sale, growing revenue, improving operating margins through cost reductions and higher-value products, and managing operating expenses to grow more slowly than revenue. No specific quarterly revenue or earnings guidance was provided. The company targeted approximately $120 million of capital investment for fiscal 2017.
Key risks include failure or delay in obtaining approvals for the Infineon transaction, transaction costs and disruption, competitive pricing and uncertain LED demand, customer and channel dependence, execution of new products, manufacturing and supply-chain risks, foreign-exchange and investment volatility, and debt-related constraints. Cree had voluntarily recalled linear LED T8 replacement lamps because of overheating and melting hazards; it expected most recall costs to be recoverable from insurance. Management said legal proceedings’ outcomes were not reasonably estimable and unfavorable outcomes could materially affect the company. Management reported disclosure controls were effective and no material change in internal control over financial reporting during the quarter.
Most important facts for investors to verify
- Whether the $850 million Wolfspeed sale closed, its final adjusted proceeds, and any retained liabilities, indemnities, or transition obligations.
- Whether the decline in Lighting Products revenue and gross margin stabilizes, and whether commercial fixture demand and consumer-bulb mix improve.
- Whether operating cash flow recovers and inventory, receivables, and the 109-day cash conversion cycle normalize.
- Whether the T8 recall costs are substantially insured and whether any additional product-quality or warranty exposure emerges.
- How Lextar’s market value, unrecognized tax benefits, and unresolved legal matters affect future earnings and cash flow.
- That reported year-over-year figures use the filing’s revised prior-period presentation, and distinguish continuing operations from discontinued Wolfspeed results.