Cree’s Q1’15 Results Hit By Weak LED Demand Though Lighting Continues To Grow Strongly

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Leading LED manufacturer Cree (NASDAQ:CREE) reported its Q1 2015 earnings on October 21st. At $428 million, revenue was in line with the company’s preliminary earnings (announced on October 2), but weaker than its initial guidance of $440 million to $465 million. Strong growth in LED lighting and Power and RF was more than offset by a 13% sequential and 20% annual decline in LED products. Lower LED revenue and a higher mix of lighting sales (which have comparatively lower margins) resulted in lower gross profit, which declined approximately seven percentage points year to year to 31.8%. Cree’s non-GAAP net income declined 42% sequentially  to $30 million, or $0.24 per diluted share.

In Q1 2015, Cree spent $68 million on capital projects and $54 million on share repurchases which resulted in negative free cash flow of $55 million. The company targets lower inventory levels and reduced capital spending in Q2 2015, as it plans to reduce the LED factory production rate (in line with demand) to support higher free cash flow over the next several quarters. In tandem, it aims to return to positive cash flow in the ongoing quarter with this reduction in both its working capital balances and its capital spending. Though Cree is lowering its LED factory capacity investments, it targets continued investment for infrastructure projects to support its longer term forecasted growth for fiscal 2016 and 2017.

Lower LED demand and margins are two keys trends impacting Cree’s near-term growth prospects. However, the company believes that the lower LED revenue, combined with recent factory productivity improvements and innovations, have created available capacity to support future growth and significantly reduce the company’s capital equipment needs for the balance of fiscal 2015.

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Our price estimate of $52 for Cree is over 50% higher than the current market price. We continue to believe in the company’s long-term growth potential. The continued growth momentum, combined with a strong balance sheet, gives Cree the flexibility to respond to new market opportunities. We are in the process of updating our model for Q1 2015 earnings.

See Our Complete Analysis for Cree Here

Lighting Segment Will Drive Future Growth

Cree’s lighting segment revenue grew 51% year on year and 7% sequentially (upper end of the guided range) driven by strong growth in LED fixtures and LED bulbs. The company is confident that growth in the lighting business will offset the slowdown in LEDs in the long term. The market for LED Lighting is still in the early stages and largely untapped in terms of installed lighting sockets. [1] Cree has a fully integrated vertical business model and is the market leader in both LEDs and LED lighting products.

The company hit a milestone in driving LED adoption a year back by launching an LED bulb for as low as $10. Cree’s bulb is the best selling LED bulb in the U.S. and has helped establish the Cree brand as the leader in LED consumer lighting. [2] Cree recently announced the ZR high efficiency troffer which is the first commercially available 150 lumens per watt LED troffer in the market. This product utilizes Cree TrueWhite Technology and reduces energy consumption by 70% when compared with traditional fluorescent troffers and is fundamentally more efficient than competing LED products. The company is also developing a next generation consumer LED bulb that delivers even better light, looks even more like a regular light bulb and at a price that gives more people a reason to switch to LED. [2]

Cree is working on its next generation LED technology platform that it believes will enable it to redefine high power LED performance. The new platform more than doubles the lumens per LED incorporating significant advancement in epitaxial structure, chip architecture, and an advanced light conversion system. The first products based on this platform are targeted to be announced in the near future with initial samples available later this quarter and the first production devices shipping in Q3 2015.

Cree remains focused on continuing to innovate and set new performance standards for LED Lighting, which it believes is key to driving lighting growth and broad LED adoption over the next several years. LED penetration is expected to increase in the future, and being one of the leading global LED manufacturers, Cree will benefit from the trend, in our view.

Higher Lighting Sales Put Pressure On Gross Margin

The rising proportion of lighting sales puts pressure on Cree’s overall gross margin as lighting products offer lower profit margins compared to LED components. A higher proportion of revenue from the fast growing lighting LED market combined with declining LED revenue is expected to put additional pressure on Cree’s gross margin in the future.

In Q1 2015, LED segment margins declined to 39% (from 46.6% a year ago), driven primarily by weaker LED demand which resulted in higher revenue reserves to reflect the more aggressive LED pricing environment and higher inventory reserves related to the factory over build. Cree’s lighting margin declined to 24.9% in the quarter (from 26.9% a year ago), driven by a higher mix of LED bulb products, a less favorable mix within LED fixtures and lighting factory execution challenges.

Cree believes the mix will shift more favorably back to fixtures in Q2 2015 and forecasts the lighting factory productivity to improve over the next several quarters. The company targets its overall non-GAAP gross margin to increase by 110 basis points sequentially in Q2 2015 on account of a more favorable mix of LED lighting sales and lighting factory productivity improvement.

Q2 2015 Outlook

– Revenue in the range of $400 million to $420 million. Single-digit growth in lighting sales with strong LED fixture growth partially offset by lower LED bulb sales. LED sales down approximately 12% due to lower overall demand and channel inventory reduction, and Power and RF in the similar range as Q1 2015.

– Non-GAAP gross margin of 33.5% and GAAP gross margin of 32.6%.

– GAAP operating expense to increase approximately $2 million due to incremental sales experienced associated with higher fixtures revenue and incremental legal spending.

– Tax rate of 22.5%.

– GAAP net income and non-GAAP net income to be between $6 million to $10 million and $24 million to $29 million, respectively.

– GAAP and non-GAAP EPS between $0.05 to $0.09 and $0.20 to $0.24 per diluted share, respectively.

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Notes:
  1. Cree’s (CREE) CEO Chuck Swoboda on Q1 2015 Results – Earnings Call Transcript, Seeking Alpha, October 21, 2014 []
  2. Cree’s (CREE) CEO Chuck Swoboda on Q4 2014 Results – Earnings Call Transcript, Seeking Alpha, August 12, 2014 [] []