LED maker Cree (NASDAQ:CREE) saw its shares fall out of bed Thursday morning, after the company issued a profit warning Wednesday afternoon. Management now expects revenue of $106.7 million, which is at the low end of earlier guidance -- not a big deal in my opinion. However, Cree expects its profit to fall below the forecasted range of $0.22-$0.24 per share.
The company blames the tough quarter on production problems that prevented it from meeting demand. Management forecasts that the production issues will cause gross margins to plummet to around 42% from 48% in the previous quarter. This is a reversal from what occurred in 2005 when manufacturing improvements (and a switch to larger three-inch wafers) caused gross margins to rise to 52% from 47% during 2004.
Despite Cree's laying the blame on the process engineers, other issues are likely at play as well. Aggressive Asian competition is giving rise to steep declines in pricing for LEDs, which means the company has to reduce manufacturing costs at a similar rate in order to maintain profitability. Apparently it came under the bar in this regard this quarter.
Meanwhile, slowing growth in the primary high-brightness LED market -- mobile devices -- is also pressuring the stock. During 2005, 52% of high-brightness LEDs were consumed by the mobile device segment, so the maturing of this market has caused a big drop in the growth rates of LED suppliers. In 2005, the high-brightness LED market grew only around 6%-8%, depending on whom you want to believe (market research firm Strategies Unlimited provided the lower figure). In comparison, this segment grew 46% per year from 2001 through 2004, so the slowdown has been dramatic. Cree's revenue trends reflect this, with revenue growth for fiscal 2006 expected at around 8.7%, compared to 27% in 2005.
Cree's problems are similar to those of many other tech companies in other markets -- for example, NAND flash. Although NAND flash producers like SanDisk (NASDAQ:SNDK) had a great 2005, the strong growth prospects for their products have resulted in huge capacity additions by the established manufacturers and have caused new competitors to jump into the market, as evidenced by Micron (NYSE:MU) and Intel's (NASDAQ:INTC) joint IMFT venture. There is a very real chance that, at least for 2006, all the added capacity plus weakening end markets will prevent the kind of profitability that caused NAND flash manufacturers to make capacity additions in the first place.
The positive note for Cree is that significant growth in applications like automotive headlamps, LCD backlighting, and general illumination is on the horizon. LCD backlights and headlamps for cars should be meaningful contributors by 2007 or 2008. As a result, Strategies Unlimited expects the overall high-brightness LED market to perk up and grow by 15%-20% per year over the next five years.
Cree investors have suffered for a long time, as this chart shows. Nevertheless, to invest even at this new price requires that you believe the Strategies Unlimited growth forecast is on target and that Cree will be able to successfully fend off the competition. It will be interesting to see how things turn out.
Turn on the bright lights with these related links:
- Cree's had its ups and downs.
- Follow where technology leads.
- Remember the NAND rush of '06?
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Fool contributor Dan Bloom owns shares of Micron and Intel. You are welcome to send comments to him.
