Cree's Quarterly LED Product Revenue Falls 21% Amidst Restructuring

For full-year fiscal 2015 (ended 28 June), Cree Inc of Durham, NC, USA has reported revenue of $1.63bn, down just 1% on fiscal 2014's record $1.65bn. Specifically, revenue for Lighting Products (mainly LED lighting systems and bulbs) grew 28% from $706.4m (43% of total revenue) in fiscal 2014 to $906.5m (55% of total revenue), driven by commercial lighting growing 37% while consumer lighting grew just 2%. This was offset by revenue for LED Products (LED components, LED chips, and silicon carbide materials) falling 28% from $833.7m (51% of total revenue) to $602m (37% of total revenue). Power & RF Product revenue grew 15% from $107.5m (6% of total revenue) to $124m (8% of total revenue), driven by Power products.

For fiscal fourth-quarter 2015, revenue was $382.2m (well below the $420-440m forecast given in April, but slightly above 24 June's revision to $375m). This is down 12% on $436.3m a year ago and 7% on $409.5m last quarter. Specifically, Power & RF Product revenue was steady at $30.8m (8% of total revenue). Lighting Product revenue was $229m (60% of total revenue), up 2% on $224m last quarter (55% of total revenue) – driven by double-digit growth in commercial lighting – and up 10% on $208.4m (just 48% of total revenue) a year ago. However, this was mostly offset by a larger-than-expected seasonal decline in LED Product revenue to $122.2m (32% of total revenue), down 21% on $154.4m (38% of total revenue) last quarter – due primarily to lower consumer bulk sales, higher-than-expected erosion of LED average selling prices (ASPs), and Cree's restructuring (which reduced available LED fab capacity by about 40% during fiscal Q4) – and down 39% on $199.5m (as much as 46% of total revenue) a year ago.

On 24 June, in order to improve cost structure, Cree announced a restructuring of its LED business to reduce excess capacity and overhead (by consolidating two fabs in Durham into one, taking till the end of the December quarter). The firm is also increasing LED reserves to reflect the more aggressive pricing environment during the quarter, and to factor in a more conservative pricing outlook for fiscal 2016. During the quarter, Cree hence recognized $84m of restructuring charges ($27m of LED revenue reserves, $11m of LED inventory reserves, and $46m of factory capacity and overhead cost reductions).

On a non-GAAP basis, due mainly to the LED restructuring charges, gross margin fell further, from 37.9% a year ago and 31.4% last quarter to 21% (well below the originally forecast 32%). Specifically, LED Product gross margin plummeted from 35.9% last quarter to just 7% (in line with updated targets provided on 24 June). Power & RF Product gross margin was 52.5% (similar to last quarter). Lighting Product gross margin fell from 26% to 24.8%, slightly lower than targeted due primarily to lower consumer lighting margins (as a result of lower sales volumes) and year-end items related to commercial lighting (which was otherwise in line with last quarter).

For full-year fiscal 2015, Lighting Product gross margin was 26%, down year-on-year due mainly to lower LED bulb margins (in a more competitive pricing environment). LED Product gross margin fell to 31.7%. Power & RF Product gross margin was 54.7%. Overall gross margin fell from 38.2% in fiscal 2014 to 29.9%.

Quarterly operating expenses were level with last quarter, at $108m (within the revised targeted range after accounting for the restructuring cost).

Due mainly to the LED restructuring, for fiscal Q4/2015 Cree made a net loss of $20.5m ($0.19 per diluted share), compared with the originally forecasted net income of $26-31m ($0.24-0.28 per diluted share), and net income of $25m ($0.22 per diluted share) last quarter and $51.3m ($0.42 per diluted share) a year ago. For full-year fiscal 2015, net income was $72m ($0.64 per diluted share), down from $203m ($1.65 per diluted share) for fiscal 2014, as profit growth in Lightning and Power & RF was insufficient to offset the significant decline in LED profits and the related restructuring costs.

Cash generated from operations rose from $65.6m last quarter to $88m. As well as the regular patent spending of about $5m, spending on property, plant & equipment has risen from $44.9m to $48m, raising total capital expenditure from $50m to $53m. Free cash inflow was hence $35m (the highest quarterly level in a year and a half), more than doubling from $15.8m last quarter. However, during the quarter Cree spent $160m on repurchasing its stock. Cash and investments consequently fell by $69m from $782m at the end of fiscal Q3/2015 to $713m.

Also, in mid-May, Cree submitted a draft registration statement to the US Securities and Exchange Commission (SEC) for a potential initial public offering (IPO) in fiscal 2016 of its Power & RF business. The spin-off aims to raise capital to invest directly in the business to support targeted future growth, while also enabling Cree's management to focus on its LED and Lighting businesses. As part of the separate focus on the Power & RF business, in early July Cree acquired power module provider Arkansas Power Electronics International Inc (APEI) of Fayetteville, AR, USA, aiming to accelerate the market for its Power & RF business' SiC power modules.

"The restructuring will better position the LED business to focus on our new market-leading high-power products with a reduced cost structure going forward," says Swoboda. Over the last year, Cree has added manufacturing partners (such as Taiwan's Lextar) for both low/mid-power LED chips and LED lighting products that should provide long-term cost leverage, enabling Cree's factories to focus on new-product introduction and technology, especially high-power LED chips (which Cree continues to make itself, because it can get the performance – "We still can't buy them on the open market," notes Swoboda). "We believe the LED market will remain very competitive for at least the next year, but target the combination of design wins for our new SC5 LED products [launched last October with XHP Extreme High Power LEDs] and lower cost structure to help offset the competitive challenges in the market," he adds.

"The actions we took in Q4 to restructure our LED business [once fully completed in fiscal Q2/2016] position us for solid revenue growth and margin expansion in fiscal 2016, driven by the strength of our commercial lighting business," says Swoboda. "Q1 total company backlog is tracking with our targets for the quarter as commercial lighting orders are ahead of Q4."

For fiscal first-quarter 2016 (ending 27 September 2015), Cree targets revenue of $410-430m, driven by Lighting sales (with strong growth in commercial lighting sales plus LED bulb sales flat to slightly higher), LED sales in a similar range to fiscal Q4/2015 (excluding the impact of the revenue restructuring reserves), and incrementally higher Power & RF revenue. Aided by the restructuring, gross margin should rebound to 32%, with LED Product margin boosted by benefits from a global LED chip patent cross-licensing deal agreed with Epistar in early August (under which Cree receives a licensing fee and royalty payments from Epistar). Operating expenses are targeted to be roughly level at $107m, as core spending reductions are partially offset by higher IP litigation spending. Net income is expected to be $19-24m ($0.18-0.23 per diluted share).

"The LED business remains very competitive and we are taking a cautious approach to this market with our distributors," says Swoboda. "Our targets for fiscal 2016 include managing LED distributor inventory to increase their returns and further reduce our exposure to changes in pricing going forward."

Factory utilization is improving in LEDs as Cree executes its restructuring plan, and is targeted to recover to 85% by the end of December when factory consolidation is completed. "Factory execution continues to be critical to achieving our targets," comments Swoboda.

Cree now targets total restructuring cost to be $102m, including $18m of additional charges in the first and second quarters of fiscal 2016 as it completes the consolidation of its LED factories. "Primarily related to additional capacity and overhead cost reduction identified during the factory consolidation process, we're finding the estimated fair values on certain equipment being held for sale," says chief financial officer Michael McDevitt.

For fiscal 2016, Cree aims for revenue growth of 10% to $1.8bn (with growth driven by commercial lighting, compensating for consumer lighting being flat to slightly down), with operating margin of 8%. The firm targets property, plant & equipment (PP&E) spending to be lower than fiscal 2015, at $150m (primarily in first-half fiscal 2016), in order to complete certain existing infrastructural projects and to provide Lighting and Power & RF with incremental capacity. Free cash flow is targeted to be $85m (more in the second half of fiscal 2016 than the first half). Finally, Cree's board of directors has approved a $500m stock buyback program for fiscal year 2016.