NEW YORK ( TheStreet) -- Is it ever possible for a stock in the LED space to have a non-eventful earnings day? That hasn't been the case for shares of LED bellwether Cree ( CREE - Get Report), yet some Cree watchers are saying that when Cree reports on Tuesday after the close crickets might be heard.

Cree already put the bad news out there when it pre-reported a revenue miss on March 23, and its shares are down 15% since then. Even though Cree has bounced off a series of 52-week lows which culminated in a share price of $40.25 last week, the bounce has been more like a falling forward for Cree shares, with the LED stock at $41.07 on Monday.

In March, Cree warned revenue would be in a range of $215 million to $220 million, a significant shortfall.

Chuck Swoboda, Cree's CEO and chairman, said at the time of the earnings guidance revision, "Despite the challenges we faced in Q3, distributor sell-through has improved and we target solid growth next quarter. Based on our preliminary outlook for Q4, we are currently targeting revenue to increase 10 to 12% in fiscal Q4 led by growth in LED components."

Given the bad news from Cree -- the third quarter in a row during which the company has failed to meet guidance -- it might seem logical to call a bottom in Cree shares, but doing so might not be taking into account the extent to which shorts hover around Cree shares, and the margin for error left in Cree's own gross margin guidance. Furthermore, long-time bears on Cree are sticking with the structural argument against the company and shrugging off the potential for earnings volatility, because of their belief that it gets worse for Cree, even if it gets marginally better for one quarter.

Hans Mosesman, Raymond James analyst and a long-time bear on shares of the LED company, said in an email to TheStreet, "An in-line quarter and outlook from Cree and the stock probably does nothing. An in-line top line with declining gross margins is a bad omen given that they've already guided the June revenue up 10% to 12%. As always, this stock is rather difficult to predict in terms of next-day direction, hence why we tend not to engage in the post earnings guess-work given our view of a structural problem for Cree going forward."

Cree said in its March guidance update that gross margin for the quarter would be 43%, but it's whether Cree guides higher or lower than 43% for the June quarter that could decide the short-term fate of Cree shares for those who do engage in the post-earnings guess work.

Several analysts, including Ben Schuman, an analyst at Pacific Crest Securities, told TheStreet that the level of volatility in the Cree earnings trade could come down to whether it can maintain that 43% gross margin guidance. If it can raise that guidance or just keep it flat, shorts might cover and wait for their next chance to pressure the LED stock, pushing Cree shares up post-earnings. On the other hand, if Cree signals any more gross margin weakness -- and, in particular, if gross margins dip below the key threshold of 40% -- it could be one more difficult day for Cree shares.

Pacific Crest's Schuman said that investor expectations are currently lower than Street consensus for Cree -- even as the Street has taken numbers down based on the Cree guidance -- and that when investors are more pessimistic than the Street, it leaves room for volatility in the earnings trade.

Several bearish Cree analysts have already predicted further gross margin weakness for Cree.

"Gross margin at a level even a little worse, or better, and we could see a significant amount of short covering; but if gross margin is under 40%, we could see the stock continue to trade off," Schuman said. "In terms of the June quarter and gross margin guidance, I think investors will take Cree management at its word, even though it has been wrong with guidance several quarters in row," the analyst added. Since the company has already guided revenue up by 10% to 12% for the June quarter, it has to maintain its gross margin profile in line with the top line, or else the weakness in Cree's pricing will translate into further compression of its historical stock premium.

Cree is working off two inventory issues at once: the excess inventory in the LED channel and the excess inventory on its balance sheet. If the price of inventory coming down in the June quarter is gross margins tanking, it could be another difficult day for Cree. Cree commentary on the state of channel inventory will also be a key sector read.

"If they guide margins down, it's the death spiral for Cree," said another LED analyst who couldn't be quoted without a lengthy process of compliance approvals. The analyst added, "There is not enough interest to get a majority of the bulls in, so the shorts will dictate the post-earnings trade in Cree shares either way, either pressing the shares further or covering."

Raymond James' Mosesman said, "It's gross margin and inventories." The analyst added that general commentary on ASP trends and channel visibility will be secondary, and noted that although Wall Street may like to key in on potential longer-term gross margin guidance, he doubts Cree will offer that until the fiscal year is over.

Additionally, Cree's management may still have the best visibility of any company in the sector, but its ability to forecast has more doubters than ever after its recent string of misses. If there is a perspective from which this quarterly Cree earnings is less important, it's that Cree's call that revenue will rebound by 10% to 12% in the June quarter is a point of uncertainty that won't be answered on Tuesday.

On the other hand, given the hits Cree management has taken in terms of its ability to provide visibility into the LED market after its recent string of misses, any long-term gross margin guidance provided by Cree is likely to be taken with a grain of salt by investors.

This doesn't mean that Cree bulls have departed in droves while the shorts have piled in. In fact, a recent poll of investors conducted by TheStreet showed that even amid the short pressure, Cree still has the backing of long-term investors.

The response from investors in the poll showed that the long-time bifurcation of the Wall Street view of Cree remains in place headed into earnings. Roughly 77% of poll respondents said that even with the third earnings disappointment in a row, Cree shares were a buy -- yet 23% of poll takers said even after the latest dip in Cree shares to a 52-week low, shares of the LED company are still a sell.

"More downside has been priced into Cree shares, but there is enough gross margin uncertainty to see volatility," Pacific Crest's Schuman said.

Cree may be the 800-pound gorilla in the LED space, but when it comes to LED earnings, some other niche LED plays have been the better performers.

Rubicon Technology ( RBCN - Get Report), which produces the core sapphire substrate used in the LED sector, is similar to Cree in being a target of short investors, but has departed ways with Cree in recent earnings trades. Rubicon defied the shorts in its February earnings, beating the Street and its shares are up 28% this year. Even with its recent rally and the short interest in Rubicon shares, some analysts expect the sapphire substrate provider to beat again, with the real crunch in its market not occurring until later this year, and short-term help from the Japanese tsunami taking some competitors into a production bottleneck.

"The bottleneck holds pricing firm for Rubicon and unit demand is improving, and more generally, sapphire wafer market constraints benefits them for at least six months, so it's hard to short in front of that," said one LED analyst. "It's still up to the shorts, and the Rubicon short interest is really high, but it's hard to keep pressing on the short as they continue to guide gross margins high," the analyst added. Rubicon will report earnings after the market close on May 5.

The MOCVD equipment-making duopoly in the LED market of Veeco ( VECO - Get Report) and Aixtron ( AIXG) have also provided some earnings season volatility. Veeco will report on April 25 after the market close, and it's been a target of the bears based on the ending of Chinese government subsidies for the purchase of MOCVD equipment. Veeco rallied strongly after its last earnings, even though the fears of a slowdown in China have trailed the stock since last year. Veeco shares are up 9% this year.

While the potential pullback in China has dogged Veeco, it hasn't dogged Germany's Aixtron to the same extent Aixtron has been behind Veeco in penetrating the Chinese market. Yet this provides its own rationale for being cautious on Aixtron shares. Aixtron trades at a premium to Veeco, and it's in Aixtron primary markets of Taiwan and Korea where the slowdown in MOCVD equipment ordering isn't a guessing game, but a recent reality.

-- Written by Eric Rosenbaum from New York.


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