Cree’s quarterly revenue drop 15% as US commercial lighting sales fall 12% short of expectation

For fiscal third-quarter 2017 (to 26 March), Cree Inc of Durham, NC, USA has reported revenue of $341.5m, down 7% on $366.9m a year ago and 15% on $401m last quarter (and at the low end of the targeted range of $340-370m).

“Our Wolfspeed and LED Products businesses performed at or above their targets for the quarter,” notes chairman & CEO Chuck Swoboda.

Revenue for the Wolfspeed business (Power & RF devices and silicon carbide materials) was $56.1m (16% of total revenue), up 3.7% on $54m (13.5% of total revenue) last quarter and 29% on $43.7m (12% of total revenue) a year ago (and above the expected $55m).

Revenue for LED Products (chips and components) was $131.3m (39% of total revenue), above the targeted range due to better-than-expected demand (as well as also reducing distributor inventories). However, this is down 4.9% on $138m last quarter and down 3% on $135.5m a year ago.

Revenue for Lighting Products (mainly LED Lighting systems and bulbs) was $154m (45% of total revenue), down 26% on $208.9m last quarter and down 18% on $187.7m a year ago. This is 12% lower than targeted due to (1) the US commercial lighting market being seasonally slower than forecast (as was also reported by several other manufacturers) and (2) the win rate being lower on quoted projects due primarily to delays related to lingering effects of the third-party supplier driver issue that impacted product quality in fiscal Q2.

The lower commercial lighting revenue also resulted in under-utilization of Cree’s factory which, along with the higher warranty reserves, caused a decrease in gross margin.

Lighting Products gross margin was 23%, down from 26% a year ago and 35.8% last quarter. LED Products gross margin has fallen further, from 31.6% a year ago and 29.2% last quarter to 24.7%, due to product mix and costs associated with ramp-up of the new LED chip. Wolfspeed’s gross margin was 47%, down from 52.1% a year ago but better than targeted due primarily to improved factory productivity. Overall company gross margin on a non-GAAP basis was 25.9%, down from last quarter’s higher-than-normal 32.7% but also down on 30.6% a year ago.

Due mainly to lower variable sales expenses associated with the lower commercial lighting sales, operating expenses were $2m lower than expected, at $94m.

The sale of the Wolfspeed business to Germany’s Infineon Technologies AG for $850m was targeted to close during the quarter, but on 6 March the deal was formally terminated because the Committee on Foreign Investment in the United States (CFIUS) determined that the transaction could not be approved due to national security concerns. Results hence included two consequent items: (1) Cree was required to record an income tax expense charge of $86m to establish a valuation allowance on its US deferred tax assets and other deferred charges; and (2) Cree recorded an additional $12m in expenses (net of tax), primarily associated with the resumption and catch-up of depreciation and amortization on Wolfspeed’s long lived assets, partially offset by the $12.5m termination fee from Infineon.

Net income was $749,000 ($0.01 per diluted share), down from $29.9m ($0.30 per diluted share) and $17.2m ($0.17 per diluted share) a year ago. However, excluding the $10.3m ($0.10 per share) in resumption and catch-up of depreciation and amortization expenses related to the termination of the Wolfspeed deal, net income would have been $11.1m ($0.11 per diluted share), on the lower end of the targeted range of $10-18m ($0.10-0.18 per share).

Cashflow generated from operations was $43.4m (up from $15m a year ago). Capital expenditure (CapEx) was $24.7m. Free cash flow was hence $18.7m (an improvement on -$6.3m a year ago).

During the quarter, Cree spent $6m to repurchase 200,000 shares (making $104m on repurchasing 4.4 million shares in fiscal 2017 year-to-date). “With the termination of the Wolfspeed transaction, we have limited our stock buyback activity while we update our longer-term capital needs to support the targeted growth in Wolfspeed,” says chief financial officer Mike McDevitt.

Overall during the quarter, cash and investments rose by $18m from $421m to $439m. At the end of the quarter, Cree had $153m outstanding on its line of credit.

“The factors that impacted our lighting business are temporary and we target improvement in all three businesses in Q4,” says Swoboda.

For fiscal fourth-quarter 2017 (ending 25 June), Cree targets revenue of $340-360m, with sequential growth of 2% in Lighting Products (as growth in commercial lighting is offset by seasonally slower consumer sales) and 4% in LED Products, while Wolfspeed business is expected to be flat to slightly higher. “Our Wolfspeed business is currently limited by factory capacity, which we’ve already started to address,” says McDevitt.

Gross margin should rise to 29%, driven primarily by Lighting (due mainly to a higher mix of commercial sales plus higher factory utilization) supplemented by incremental improvements in LED and Wolfspeed margins.

Operating expenses are expected to rise by $3m to $97m, due mainly to non-recurring costs associated with right-sizing the Lighting Products business plus start-up costs for the new joint venture Cree Venture LED Company Ltd.

“Given the current state of our Lighting business, we have re-evaluated the business to identify spending that is not aligned with our current growth strategy for this business,” notes McDevitt. “During Q4, we are taking action to remove certain costs that are targeted to yield an $8m annual benefit [starting from fiscal first-quarter 2018].”

Cree is forming the joint venture Cree Venture LED Company Ltd with San’an Optoelectronics Company Inc of Xiamen, China to produce and deliver to market mid-power lighting-class LEDs in an exclusive arrangement to serve the expanding markets of North and South America, Europe and Japan. “We will be consolidating the joint venture’s operations into our results and recording the JV’s revenue and gross profit as part of our LED segment,” says McDevitt. Also, Cree will receive a royalty for IP licensed to the JV, commissions for its LED sales force selling the JV’s products, and reimbursement for administrative services performed on the JV’s behalf.

For fiscal Q4, Cree expects an increase in net income to $2-7m ($0.02-0.07 per diluted share).

For full-year fiscal 2017, Cree targets capital spending of $95m, related primarily to infrastructure projects to support longer-term growth and strategic priorities. Target free cash flow is $120m.

“While we are still developing our capital investment and free cash flow targets for our fiscal 2018, we currently estimate the company will be free cash flow positive again in fiscal 2018,” says McDevitt. “This is inclusive of the capital required to expand capacity for our Wolfspeed business, which is currently capacity constrained, but excludes capital required to support potential Lighting-related mergers and acquisitions (M&A),” he adds.

During fiscal Q4, the new Dmax LED chip platform will begin ramping into higher-volume production, which should provide some margin improvement in core high-power LED business in fiscal first-half 2018.

“The company is building a solid foundation for growth in all three businesses for fiscal 2018,” says Swoboda. “The Wolfspeed business is doing well and is in a unique position to benefit from the market shift to silicon carbide power devices and gallium nitride RF devices as both a substrate and a device supplier. The LED business is making progress with new high-power LED technology and is now positioned to grow revenue by leveraging the new JV to also serve our customers’ mid-power product needs. Our Lighting team is strengthening the fundamentals and laying the groundwork to grow revenue and profits in this business,” he concludes.