Cree Reports Strong Q2’16 Earnings Driven By A Healthy Demand In Commercial Lighting

Healthy demand in commercial lighting and improved operating efficiency achieved through restructuring efforts helped LED manufacturer Cree (NASDAQ:CREE) beat market expectations in its Q2 fiscal 16 results. (Fiscal years end with June.) The company’s performance in fiscal 2015 was impacted by a steep decline in LED prices by as much as 30% owing to an oversupply situation in the market. However, Cree’s restructuring efforts and a strong product pipeline helped it improve margins and maintain growth momentum in the first half of fiscal year 2016.

Going forward, Cree’s key priorities are:  1) to build its financial momentum; 2) to continue to innovate in each of its business segments; and, 3) to promote future growth in Power and RF products, which could ultimately improve returns for Cree’s shareholders. The company is confident that new products and lower costs from its restructuring initiatives will help improve its revenue and profitability in the second half of fiscal 2016.

We are in the process of updating our $31 price estimate for Cree.

Quick Snapshot Of The Q2 Fiscal 2016 Earnings

Led by a strong demand in commercial lighting, Cree’s second quarter revenues increased 2% sequentially and 5% year to year to $436 million, offset by the decline in Power and RF revenue. While revenue from lighting products and LED products grew 11% and 1% year-over-year, respectively, Power and RF revenues declined 12% due to macroeconomic headwinds. As Cree realized benefits from its LED restructuring initiative, it maintained its non-GAAP gross margin at 31.7% in Q2, which was within its target range. With lower operating expenses, the company’s Q2 fiscal 16 non-GAAP operating income increased by 21% to $35.5 million and non-GAAP earnings per share stood at the higher end of the company’s guidance at $0.27.

Strong Product Pipeline To Help Cree Stay Ahead In The Market

Cree’s Inventory days in hand decreased from 89 to 84, sequentially, lower than its 90 day target. The company claims that this decrease is primarily due to a strong demand for its lighting products, as it has been prolific in coming out with the latest and most efficient lighting products. While consumer lighting revenue was similar to the previous quarter, revenue growth in Cree’s lighting segment was primarily led by the growth in commercial lighting.

The company is targeting release of new products based on WaveMax technology over the next few quarters that can drive future growth. Cree’s Wave max technology in LED lights provides a combination of control, uniformity and efficiency to deliver superior visual experience.  Furthermore, the company is targeting to expand its product line to a new market segment, namely, smart and connected lights. Cree’s efforts in this segment are focused on building intelligent lighting systems with key functionalities. The company claims to win new designs from its high-power LED products such as SC5 technology platform that provides improved performance and lower system cost. We believe that Cree’s efforts to expand its product line by continuous innovation will provide the company an edge over its competitors to stay ahead in a continuously evolving LED and lighting market.

Company’s Restructuring Efforts Have Started To Pay-off

Although the overall LED market landscape remains very competitive, Cree claims to see its LED business stabilizing. The company saw improved LED revenues and gross margins in Q2 as it started to reap benefits of its restructuring efforts. In an effort to adjust capacity, reduce overhead and increase LED reserves, Cree decided to restructure its LED business in fiscal Q3 2015 (i.e., January to March) and as a result, incurred $102 million of restructuring charges in 2015.

During the second quarter, the company saw a 60 basis points increase in the lighting gross margin and better utilization rates, owing to the improved factory execution due to factory consolidation. Going ahead, Cree is targeting to achieve more operating  efficiencies and better margins. However, with a lot of variability in in the LED market dynamics and the ongoing evolution of LED-based lighting systems, it is hard to predict where the margins for Cree will stabilize. Nevertheless, with the completion of its restructuring efforts in the current quarter, the company’s LED business will benefit from a reduced cost structure. By having a low cost structure, the company can enjoy higher margins on its products or win additional market share by passing on the benefits to customers in the coming quarters.

Q3 2016 Outlook

– Revenue in the range of $400 million to $430 million.

– Non-GAAP and GAAP gross margin of approximately 31.7% and 31%, respectively, driven by an incremental gross margin improvement in commercial lighting sales due to factory cost improvements.

–  Non-GAAP and GAAP operating expense of approximately $100 million and $119 million, respectively.

– Tax rate of 20%.

– GAAP net income between $4 million to $11 million. GAAP EPS target is between $0.04 and $0.11 per diluted share.

– Non-GAAP net income in the range of $22 million to $29 million. Non-GAAP EPS between $0.22 to $0.29 per diluted share.

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