10 February 2020
Cree’s quarterly revenue falls less than expected as LEDs counteract China-related trade, 5G and EV issues
For fiscal second-quarter 2020 (ended 29 December 2019), Cree Inc of Durham, NC, USA has reported revenue of $239.9m, down 14% on $280.5m a year ago but only 1% on $242.8m last quarter, and at the top of the $234-240m guidance range.
LED Product revenue was $119.2m (50% omf total revenue), down 18% on $145.2m (52% of total revenue) a year ago but up 4% on $115.1m (47.4% of total revenue) last quarter (amid ongoing soft market conditions and Chinese trade and tariff issues) and above the targeted range.
Revenue for Cree’s Wolfspeed silicon carbide (SiC) materials, power and gallium nitride (GaN) RF device business was $120.7m (50% of total revenue), down 11% on $135.3m (48% of total revenue) a year ago and 5.5% on $127.7m (52.6% of total revenue) last quarter (and towards the far end of the guidance range of down 3-6%). The drop is due to ongoing weakness in power & RF device sales. “While we continue to see growth in our materials business, our power business continues to be impacted by softness in electric vehicle (EV) sales in China, with a sharp decline seen in the second half of calendar 2019, following the withdrawal of government EV subsidies,” notes chief financial officer Neill Reynolds. “In our RF business, we are experiencing continued delays in purchasing activity, as it relates to the rollout of 5G networks,” he adds.
Also, last May the US Department of Commerce added China’s Huawei Technologies to its ‘Entity List’ prohibiting the sale to Huawei of products covered by the Export Administration Regulations (EAR) without obtaining a license. “Recently, we received notice from the US Department of Commerce that our license application to resume shipment of product to Huawei would not be granted… We will continue to comply with the ban as it relates to Huawei and do not currently expect to record any RF revenue for this customer during fiscal 2020,” says Reynolds. “Considering this development and the fact that it has been eight months since the ban has gone into effect, we don't see any opportunity at this time where we will resume shipping any product we currently have on hand to the customer,” he adds. “As such, we have taken an inventory reserve on Huawei-related products,” notes CEO Gregg Lowe.
On a non-GAAP basis, gross margin has fallen further, from 38% a year ago and 31% last quarter to 26.8% (below the targeted 30%), although the sequential decline was almost entirely due to an impact of 350 basis points from the Huawei inventory reserve of $8.3m.
By sector, Wolfspeed gross margin has fallen further, from 48% a year ago and 46.3% last quarter to 34.6% (or, without the Huawei inventory reserve, 41% - at the bottom of the targeted range of 41-44%). This was also impacted by lower materials factory utilization and lower yields related to ramp-up of the new firm’s 150mm SiC MOSFET product.
LED gross margin was 22.2%, down from 30% a year ago but up from 19.2% last quarter (and above the targeted 19.5-20.5%), due mainly to improved factory utilization, lower impact from tariffs, improved product mix and ongoing cost measures.
Operating expenses were $85m (35.4% of revenue), up only slightly on $84m (34.6% of revenue) last quarter.
Compared with net income of $21.9m ($0.21 per diluted share) a year ago, net loss from continuing operations has risen from $3.6m ($0.03 per diluted share) last quarter to $10.4m. However, $8.3m of this came from a reserve on inventory related to Huawei, doubling the loss per diluted share from $0.05 to $0.10 (i.e. from above the midpoint of the targeted range to below it).
“If you adjust for the impact of the reserve, we exceeded the midpoint of the guidance for revenue, gross margin percentage and EPS,” notes Lowe.
Cash generated from operations was $8.2m (down on $68.7m a year ago, but a recovery from cash outflow of -$20m last quarter). Capital expenditure (CapEx) was $61m (rising again, from $43m last quarter). Free cash outflow was hence -$53m, as Cree continues to invest for growth to expand capacity in its Wolfspeed business.
During the quarter, cash and short-term investments hence fell from $994m to $952m. The firm has zero balance on its line of credit and convertible debt with a face value of $575m.
“While we continue to navigate a challenging operating environment in the short-term, we continue to invest for the future to support several growth opportunities across multiple sectors,” says Lowe. Last May, Cree started a multi-year factory optimization plan, to be anchored by an automated 200mm silicon carbide wafer fabrication facility, which in September it announced would be built in Marcy, NY (Mohawk Valley), complementing the ‘mega materials’ factory expansion underway at its US campus headquarters in Durham (forming a ‘silicon carbide corridor’ on the East Coast of the USA). “We continue to see growing momentum for silicon carbide, as demonstrated by our robust opportunity pipeline and recent customer wins,” says Lowe. “We were awarded new design-ins for Wolfspeed products totaling hundreds of millions of dollars... Customers tell us that they expect to make decisions on about half of our $9bn device pipeline over the next 6-18 months. We are working hard to convert these opportunities into wins.”
For fiscal third-quarter 2020 (to end March), Cree expects revenue to fall further, to $221-229m. Wolfspeed revenue should be $116-120m, flat to slightly down sequentially as the firm continues to face external headwinds, softness in 5G network spending, and lower electric vehicle sales in China. LED Products revenue is expected to be at the lower end of typical fiscal Q3 seasonality, at $105-109m (down about 10% sequentially, compared with the normal seasonal drop of 5-10% due to the Chinese New Year holiday).
These targets reflect the Chinese government’s decision on 27 January to extend the Lunar New Year holiday due to the coronavirus outbreak. So, Cree’s LED factory in China was due to reopen only on 10 February. The outlook does not account for any future measures taken by the Chinese government that could further delay business from returning to a normal operating schedule. Reynolds reckons that China contributes about 40% of Cree’s LED Product revenue (albeit slightly less in fiscal Q3) but only 10% of Wolfspeed’s revenue (which is therefore less impacted). “We do have some suppliers in China related to Wolfspeed,” he notes. “As things stand today that seems to be working.”
Gross margin should be about 30%. LED gross margin is targeted to be 20-21%, down slightly due to lower licensing revenue and lower volumes partially offset by improved cost execution. Wolfspeed gross margin is targeted to be 39-42% (roughly flat on fiscal Q2, excluding the effect of the Huawei inventory reserve). “We are working through temporarily lower-than-expected yields on our 150mm MOSFET product line [due to a significant scrap event in the Durham fab last quarter, since resolved]. While we saw improvements during the previous quarter, yields have not yet fully returned to expected levels,” notes Reynolds. “In addition, given lower 5G demand, we have lowered our utilization in our RF business, further impacting gross margin,” he adds. “We expect to return to higher levels of gross margin once the yield improvements are implemented and the volumes increase. It may however take a full manufacturing cycle to see these results in our financial statements once the improvements take hold.”
For fiscal Q3, operating expenses should grow to $88m as Cree continues to invest in its Wolfspeed business, including increased investment to prepare products for production in the fab in Mohawk Valley (which it plans to ramp in 2022). Cree expects net loss to rise to $16-10m ($0.15-0.09 per diluted share, impacted by about $0.02 due to the ongoing effects of tariffs).
For full-year fiscal 2020, Cree has now increased its targeted CapEx from $200m (announced at the firm’s Investor Day last November) to $230m (followed by more than $200m annually for the next couple of years after this). “Power device customers have recently indicated that their production schedules may be earlier than originally anticipated, which will require more manufacturing capacity than we have in our current plan,” reports Reynolds. “Given the time required to install and qualify these tools, we have decided to invest now to ensure we have maximum flexibility in the event our customers need us to ramp our production sooner. These were tools we were planning to purchase in fiscal 2021, but have decided to invest now so we have some additional buffer for our planned ramp,” he adds. “There’s no change to our overall capacity expansion plans. Our capital allocation priorities remain focused on expanding capacity in our Wolfspeed business. We’re pulling CapEx in just to ensure we have enough buffer and flexibility to meet our customers’ needs based on the feedback that they’ve given us,” Reynolds explains. “As we build out the Mohawk Valley fab and we get the benefits of the incentives from that program, we’re actually going to see that CapEx go down as that factory starts to ramp based on the partnership we have with the State of New York. During that period the [fiscal] 2020 and 2021 timeframe are very much investment years. That will drive some negative free cash flow in advance of those ramps.”
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