Cree’s Q1 2015 Earnings Preview: New Innovation Can Accelerate Growth In Fiscal 2015

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Leading LED manufacturer, Cree (NASDAQ:CREE) is set to report its Q2 2015 earnings on January 20th. Driven by strength across its product portfolio, particularly the lighting segment, the company witnessed a 19% increase in its fiscal 2014 (ended June) revenue, which totaled $1.65 billion. Though its lighting sales continued to grow in Q1 2015, Cree’s revenue in the quarter was hit by weak LED demand. For Q2 2015, the company estimates revenue in the range of $400 million to $420 million, with single digit growth in lighting sales and double digit decline in LED sales.

Lower LED demand and margins are two keys trends impacting Cree’s near-term growth prospects. Cree plans on  lower inventory levels and reduce capital expense 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 Q2 2015 with this reduction in both its working capital balances and its capital spending.

Our price estimate of $41 for Cree is at a significant premium (~30%) to the current market price. We will update our valuation after the Q2 2015 earnings release.

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See Our Complete Analysis for Cree Here

Continuous Innovation Can Help CREE Leverage LED Lighting Growth

Cree is one of the leading LED players committed to driving global LED adoption and closing down the price gap with conventional lighting through innovation. Product innovation over the last few years has opened new applications and improved LED returns, in turn driving demand for Cree’s products. The company 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 LED 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. [1] 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 and looks even more like a regular light bulb, all at a price that gives more people a reason to switch to LED. ((Cree’s (CREE) CEO Chuck Swoboda on Q4 2014 Results – Earnings Call Transcript, Seeking Alpha, August 12, 2014))

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 advances in the epitaxial structure and chip architecture, as well as including an advanced light conversion system. The first products based on this platform are expected to be announced in the near future;  initial samples should be available later this quarter and the first production devices should ship in fiscal Q3 2015.

Additionally, as we wrote in August, Cree’s recent collaboration with Lextar, can help expand its footprint in the mid-power LED segment. Lextar is a vertically-integrated LED company and has a strong technology position and customer base in the mid-power backlighting LED segment. Cree, on the other hand, offers outstanding performance in the high-power LED component and lighting market.

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 stated the mix should shift more favorably back to fixtures in Q2 2015 and forecasts the lighting factory productivity to improve over the next several quarters. The company’s guidance suggests its overall non-GAAP gross margin will  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.

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