Cree’s Q3’17 Earnings Hit By Lighting Business Under-Performance; Feels The Pinch Of Wolfspeed Sale Termination

Q3 2017 failed to provide a respite to LED manufacturer Cree (NYSE:CREE), which saw its top line and profitability continue to decline in the quarter. While the company’s earnings were impacted by the termination of the Wolfspeed sale, even removing the impact of the same resulted in the revenue and EPS figures coming in at the lower end of the company guided range and below analyst expectation. Cree’s Q3 2017 results included two items (which were partially offset by the Infineon termination fee of $12.5 million) that were not accounted for in the guidance because of the pending sales of its Wolfspeed business:

1. An income tax expense charge of $86 million to establish a valuation allowance on Cree’s US deferred tax assets and other deferred charges.
2. An additional expense of $12 million associated with the resumption and catch-up of depreciation and amortization on Wolfspeed’s long lived assets.

While the Wolfspeed and LED business were at or above Cree’s target range for the quarter, the Lighting revenue was about 12% lower than targeted. In addition to the industry slowdown, which impacted other lighting manufacturers in the quarter, Cree’s lighting business was impacted by a third-party supplier driver issue. The company is confident of fixing the situation this quarter, though the lighting business might still feel the impact of the overall industry slowdown and take time to fully recover as Cree realigns its business.

Note – Excluding the Wolfspeed termination adjustments, Cree’s Q3 2017 GAAP and non-GAAP diluted EPS stood at -$0.01 and $0.11, respectively.

See our complete analysis for Cree

Factors That Could Help Drive Growth In The Future

– Building capacity in the Wolfspeed business: Cree is working on increasing its capacity and further developing the technology to support longer-term growth opportunities in silicon carbide materials, silicon carbide power devices and modules, and gallium nitride RF devices. The company is seeing significant demand in silicon carbide and is currently working on maximum capacity.

– Expanding LED product portfolio: Cree is expanding its LED product offering with new high-power and mid-power products that leverage its market leadership. The company has entered into a joint venture with San’an, which can help Cree increase its presence in the mid-power LED component market. (Read Press Release)

– Growing Lighting revenue and increasing margin: by investing in channel relationships, improving execution, and continuing to deliver innovative lighting solutions.

Lighting Business Will Take A Few Quarters To Build Any Significant Growth Momentum

As mentioned above, Cree’s lighting business performed worse than expected because of two primary factors –

– Slowdown in the U.S. commercial lighting market: Cree claims that the commercial lighting market in the U.S. was seasonally slower than anticipated which resulted in under-utilization of its factory, which combined with higher warranty reserves led to a decline in lighting gross profit. Cree believes that even though Q3 2017 was soft, the non-residential construction market will pick up in subsequent months. With an expanded product range, the company hopes to get into new applications, which can drive growth going forward.

– Third party supplier issue:  Cree’s win rate in the quarter was lower on quoted projects, primarily due to delays related to lingering effects of the third-party supplier driver issue that impacted product quality in Q2 2017. The company estimates that this issue roughly accounted for half of the decline in the lighting segment. Cree has already made significant progress in fixing the issues and believes that the same will not have a material impact in the current quarter results.

Given the current state of the Lighting business, Cree has reevaluated the business to identify spending that is not aligned with its current growth strategy. As a result, it plans to take actions to remove certain costs that are targeted to yield an $8 million annual benefit. The financial benefit of this right-sizing initiative will not be fully realized until the first quarter of fiscal 2018.

Despite all the above mentioned steps, it will take several quarters to rebuild significant growth momentum in the lighting business, and thus we expect muted performance in this business for the rest of the year.

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