CREE’s Q3 ’15 Earnings Growth Driven By Lighting Revenue and New Products

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Cree

Leading LED manufacturer, Cree (NASDAQ:CREE) reported another quarter of strong growth with its Q3 2015, earnings beating analysts’ consensus estimates. (Fiscal years end with June.) At $410 million, revenues were at the upper end of company guidance, as the worse than expected weather seasonality was offset by strong growth in LED lighting.  Non-GAAP income was $25 million and diluted EPS stood at $0.22, as a lower tax rate offset reduced gross profit due to lower factory utilization, driven by inventory reductions and an unfavorable product mix. GAAP earnings per share were below Cree’s targeted range, primarily due to the $2.2 million decline in fair value of its Lextar investment which was caused by a reduction in Lextar’s share price during the quarter.

Lower LED demand and margin pressure are two keys trends which have impacted Cree’s growth prospects in the last few quarters. However, the company continues to see strong growth in its lighting segment. Cree expects LED volumes to stabilize in Q4 2015 and improve in fiscal 2016, driven by new design wins for SC5 LED products and growth in Cree’s lighting business.

In fiscal 2015 (ends with June), Cree plans to focus on the following  key priorities:  1) leverage its technology to lower up-front customer cost and further improve payback; 2) continue to drive LED lighting growth and build the Cree brand in both the consumer and commercial markets; 3) expand  its work with manufacturing partners to enable growth in LEDs and lighting; 4) allow its factories to focus on the newest technologies that are not otherwise available in the market: and,  5) generate incremental operating margin increasing revenue growth and incremental operating leverage across the business.

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Our price estimate of $37 for Cree is at a slight premium (~5%) to the current market price. We are in the process of updating our model for the Q3 2015 earnings release.

See Our Complete Analysis for Cree Here

Strong Product Pipeline And Continuous Innovation Can Help Cree Leverage Growth In LEDs

At $224 million, Cree’s lighting business increased 27% year on year, but declined 3% sequentially, as the severe winter weather in the Northeastern US delayed commercial LED fixture sales. LED component revenue, on the other hand, declined 23% year over year, but was better than expected at $154 million, as solid external customer demand offset the normal decline related to the Chinese New Year holiday.

A general shift to LED lighting in the lighting market is expected to be the primary growth driver for the LED industry, as demand from the backlight market nears saturation. LED lighting market is anticipated to grow 45% per year through 2019, driven by the declining price points and the rising interest on the part of the channel in pushing LED products to consumers. LED lighting is expected to account for 80% of the entire lighting market by 2020, creating a market that will be as big as $94 billion. [1]

Cree is confident that it is well positioned to continue to win in LED lighting. Though the company has made significant progress growing both the volume and product base of its lighting business over the last several years, it believes that there is still a lot of untapped potential in terms of both revenue and profitability. Cree claims that it continues to gain share in the commercial lighting market as the demand rebounded in late March and is expected to grow in Q4 2015, while the Cree LED bulb shapes the consumer lighting category and creates awareness for the Cree brand. The company has a strong product pipeline and is building good sales momentum for  its products.

Though the LED landscape remains highly competitive, Cree believes that its high power LED technology positions the company for long-term success in high performance LED lighting applications. The collaboration with Lextar can help Cree expand its presence in the mid-power segment.

In Q3 2015, Cree introduced XLamp MHD-E and MHD-G LEDs, high power LEDs that combine the high lumen density and reliability of a ceramic chip-on-board LED with the design and manufacturing advantages of a surface-mount package. Cree also demonstrated a proof of concept 50 kilowatt string solar inverter prototype that utilizes its best-in-class silicon carbide MOSFET and diode technologies in a power module to enable previously unattainable levels of power density and ultra-high efficiencies at one-fifth the average size and weight of today’s silicon-based inverter units. This system delivers a remarkable 50% reduction in power loss and operates it three to five times the switching frequency of conventional silicon technology.

Cree also expanded its leading LED bulb portfolio with the TW Series LED T8 Tube Replacement for consumers, making inferior linear fluorescent tubes a thing of the past. Designed for simple, wire-free installation, the Cree TW Series LED T8 Tube provides industry-leading compatibility, besting the competition in light quality and performance, all at an affordable price.

Though Cree is optimistic about its long-term prospects in the LED lighting segment, it admits that it will take the time to work through the new products design cycles and current market conditions.

Lighting Segment Margins See A Drag, To Grow In The Offing

A higher proportion of revenue from the fast growing lighting LED market, which offers comparatively lower gross margin, combined with declining LED revenue, has impacted Cree’s overall gross margin in the last few quarters. Cree’s gross margin declined from 33.1% in Q2 2015 to 31.4% in Q3 2015, primarily due to the impact of inventory reductions in LEDs and lighting.

Due to both product mix and factory under-loading in the first half of the quarter, the lighting segment gross margin decreased to 26% in the quarter. (The under-utilization was the result of both the inventory overhand and the timing of orders.)  Although the inventory reduction is causing some near-term gross margin pressure, Cree believes it is the prudent choice and in line with the company’s strategy to continue to innovate and rapidly bring new products to market to meet the evolving demands of our customers. Cree targets incremental lighting gross margin improvement on account of a favorable product mix that is forecast to drive increased gross profit in the quarter.

Q4 2015 Outlook

– Revenue in the range of $420 million to $440 million, which is comprised of strong growth in lighting revenue led by higher commercial fixture sales, flat LED sales (sequentially) and incrementally higher Power and RF revenue.

– Non-GAAP and GAAP gross margin at 32% and 31.3% respectively.

– Operating expenses to increase by $5 million sequentially due primarily to higher patent and litigation spending and higher sales commissions related to increasing lighting revenue.

– Tax rate of 9%.

– GAAP net income between $4 million to $9 million. GAAP EPS to be between $0.04 to $0.08 per diluted share.

– Non-GAAP net income of $26 million to $31 million, or $0.24 to $0.28 per diluted share.

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Leading LED manufacturer, Cree (NASDAQ:CREE)
Notes:
  1. Why Investing In Cree Looks Like A Bad Idea, Seeking Alpha, December 3rd, 2015 []