Cree, Inc. (NASDAQ: CREE) develops ultraviolet (UV) and high power-packaged light emitting diode (LED) chips. The company also manufactures SiC and GaN materials and high-power products that use its internally developed SiC and GaN materials. The company holds 333 US patents as well as several other foreign patents.
Only a handful of companies use Silicon Carbide (SiC) and Gallium Nitride (GaN) materials. Traditionally, semiconductors are made out of silicon substrates, as it is relatively easy to grow single crystals from silicon. However, Silicon carbide (SiC) has superior optical, mechanical and thermal electronic properties in that it is a more electrically stable and heat resistant material, with a higher saturation drift velocity and partial transparency in visible light. Its sensitivity to acid, alkali and moisture levels is also very low. This makes a SiC device particularly suitable for applications in high-temperature, high-power, high-frequency power and high-stress environments, as for example, in the automobile, aerospace and oil & gas industries. Although these properties were discovered in the early 1990s, technological difficulties hindered the commercial viability of SiC for use in semiconductor chips. Therefore, it was not until the late 1990s that the first SiC device became commercially available.
Several methods are used to grow single crystal SiCs. This is essentially the growth of mono/poly crystalline layers on a silicon substrate by using Metalorganic Chemical Vapor Deposition (MOCVD), gas-source Molecular Beam Epitaxy (MBE), electron cyclotron resonance (ECR), or plasma and liquid phase epitaxy techniques. Epitaxy is the growth of crystals of one mineral on the crystal base of another mineral, such that its crystalline orientation is the same as that of the substrate. The company grows the SiC crystals, manufactures the wafers, and fabricates and tests them. Most of the manufacturing and testing is done at its Durham facility in North Carolina, although some packaging of high-power products is outsourced to subcontractors. It also operates an R&D facility the Santa Barbara Technology Center in Goleta, California.
Third Quarter Fiscal 2010 Results (ended March 28, 2010)
Cree reported revenue for the third quarter of fiscal 2010 of $234.1 million for its third quarter of fiscal 2010, ended March 28, 2010. This represents a 78% increase compared to revenue of $131.1 million reported for the third fiscal quarter last year and a 17% increase compared to the second quarter of fiscal 2010. GAAP net income for the third quarter increased more than tenfold year-over-year to $44.6 million, or $0.41 per diluted share, compared to GAAP net income of $4.0 million, or $0.05 per diluted share, for the third quarter of fiscal 2009. On a non-GAAP basis, net income for the third quarter of fiscal 2010 increased 333% year-over-year to $51.3 million, or $0.47 per diluted share, compared to non-GAAP net income for the third quarter of fiscal 2009 of $11.8 million or $0.13 per diluted share.
LED revenue represented 87% of the Company’s revenue during the fiscal year ended June 28, 2009 (fiscal 2009). Cree, Inc.’s LED chip products include blue and green devices made from GaN and related materials. LED chips are solid-state electronic components used in a number of applications, available in a range of brightness levels, wavelengths (color) and sizes. Some of the Company’s customers combine its blue LED chips with phosphors to create white LEDs, which are used in various applications for indoor and outdoor illumination, and backlighting, including the backlight for full-color display screens, white keypads and the camera flash function. Some of its customer’s use it’s blue and green high-brightness LED chips for video screens, gaming displays, such as pachinko, function indicator lights and automotive backlighting.
Cree, Inc.’s LED components include a range of packaged LED products from its XLamp LED components for lighting applications to its high-brightness LED components. Its XLamp LED components are lighting class packaged LED products designed to meet a range of market needs for lighting applications, including general illumination (both indoor and outdoor applications), portable, architectural, signal and transportation lighting. Its high-brightness LED components consist of surface mount (SMD) and through-hole packaged LED products. Its SMD LED component products are available in a range of colors designed to meet a range of market needs, including signage, automotive, gaming and specialty lighting. Its through-hole packaged LED component products are available in a range of colors primarily designed for the signage market. The Company’s LED lighting products include the LR6, a six-inch architectural recessed LED down light, and the LR4, a four-inch architectural recessed LED down light, the LR24, an LED architectural lay-in, and the PAR 38 bulb, a narrow beam LED spotlight. These lighting products are targeted for new construction, retrofit and renovation projects in commercial, governmental and residential applications.
The materials products consist of SiC and GaN wafer and epitaxy products. Material product revenue represented 4% for fiscal 2009. The Company manufactures SiC wafers for sale to corporate customers who use the wafers to manufacture products for optoelectronic, microwave, power switching and other applications. Corporate, government and university customers also buy SiC materials for research and development directed at optoelectronic, microwave and high power devices. It sells its wafers as a bare wafer or with epitaxial films of SiC or GaN materials.
These products include SiC power devices and RF devices. Revenue from its power and RF products represented 5%, of revenue for fiscal 2009. SiC-based power devices operate at significantly higher breakdown voltages than silicon-based power devices and provide faster switching speeds than comparable silicon-based power devices at similar breakdown voltages. These attributes create a lower switching loss, which yields power savings due to higher efficiency, enabling smaller and more efficient systems. The SiC-based power products include 600 and 1,200-volt Schottky diodes. The Company’s customers purchase Schottky diode products for use in power factor correction circuits for power supplies in computer servers and other applications, such as solar inverters. The Company offers 10-watt and 60-watt SiC transistors, or metal-semiconductor field effect transistor (MESFET) products, as well as a variety of GaN high electron mobility transistors (HEMTs) and monolithic microwave integrated circuits (MMICs), which are optimized for either broadband amplifiers or for WiMAX applications.
Cree, Inc. also provides foundry services for bandgap MMICs. These RF circuits can be used in a variety of bandwidth communications applications, high-power radar amplifiers, electronic warfare and wireless infrastructure. The MMIC foundry service allows a customer to design its own custom RF circuit to be fabricated in its MMIC foundry, or have it provide custom MMIC design for the customer and fabricate the chips.
Cree has an experienced engineering team, which has enabled it to create a product line based on the latest technology. It is one of two companies (Infineon being the other) that first started using Silicon Carbide on Gallium Nitride substrates. Although Cree faces strong competition in the current market environment, most of the competing products are based on the older Silicon and Gallium Arsenide materials. The company is technologically ahead of the others, since it is already in the process of making competitive products from the new material/s.
The more advanced materials used by Cree necessitates that the company find higher-end applications, since the production complexities involved in the manufacture of these materials raise manufacturing costs. Also, the prime advantage of using these materials is that they remain stable at higher temperatures and when exposed to higher-frequency electric currents, and other environmental factors such as acidity, alkalinity and humidity. These extremes are more easily found in the automotive, avionics and military sectors. While CREE currently competes in mobile phones and PC and CE displays, the more stringent requirements of the automotive, avionics and military sectors, as well as the limited competition will enable it to reap greater profits, as market penetration improves. Management continues to look for new applications and new avenues of growth. Since some of the company's products are already being deployed in military operations in Iraq, we expect the government and military sector to be one of these "new" areas.
Cree's technology is being recognized in the lighting market, and management appears enthusiastic that near-term growth will be driven by lighting applications. Management expects to compete in three major lighting segments. The first is the incandescent lighting space, with application in emergency vehicles, personal lighting and so forth. The second is in the commercial lighting space, where high-pressure sodium and helium are currently being used. The third area is compact fluorescent lighting. The company's competitive strength in the commercial space comes from the lower maintenance costs and greater energy savings of its LED lighting solutions, when compared to sodium or helium lights. The compact fluorescent space, though growing, is also a future market, as the energy savings claimed by compact fluorescent manufacturers usually fall short of actual savings made. There have also been some rumblings about mercury emission and disposal, since these products use about 4 mg of mercury. It remains to be seen whether the company can leverage off these disadvantages to create a position for itself in the CFL space.
Another area of LED application is the TV, PC and notebook display market. Management expects notebooks to be the most important of the three, since the incremental cost of using LEDs in notebooks is substantially lower than in TVs and high-end monitors. This is mainly due to the color complexities that are of more importance in these displays as compared to notebook displays. Most of the top notebook makers in the U.S. are optimistic about using LEDs in notebooks. Both HP and Dell already have LED-based models, and Apple is expected to follow suit. Management expects the LED-based notebooks to gain traction as early as in the first half of fiscal 2008, followed by a broader acceptance in 2009 and beyond.
In March of 2006, Cree announced the EZBright LED chip platform. Products in this category are targeted at higher-end lighting and power applications. The series consists of the company's highest brightness chips, which although fabricated separately, allows easy attachment to other devices. They can, therefore, be packaged together with other industry-standard LED products. The XLamp 7090 power LED is the first product developed on the EZBright platform. Volume production of this white LED started in June last year, and the product has been growing very strongly since inception. The XLamp 7090 is targeted at general lighting applications such as street lamps, parking lamps and lighting at retail outlets. It can also enhance lighting quality of various consumer applications such as flashlights. The XLamp product line was up again in the last quarter, and management expects continued strong growth driven by infrastructure builds for the 2008 Olympics. Production ramp up of the EZ290 and EZR products for display and mobile light applications started in the September quarter. The new lighting and high-power components of LED continued to grow strongly in the last quarter. The company's power products for Schottky diodes continue to do well. The company had new design wins at some power supply and inverter applications, which enabled it to expand beyond the traditional server power supply applications. Management also intends to introduce the first MOSFET products this year.
Cree acquired COTCO's Luminant Device business on March 30, 2007 in exchange for 7.6 million Cree shares and $70 million in cash. The acquisition broadens the company's portfolio of LED components, which are expected to have a positive impact on its margins. The acquired product line is a perfect complement for the company's existing XLamp line. COTCO is based in China, which helps the company in two ways. China is one of the fastest growing markets for high-brightness LEDs, and management expects significant revenue synergies, as it sells its XLamp product line into COTCO's customer base, and sells COTCO products into Cree's customer base. Further, COTCO's Chinese factory is a low-cost manufacturing unit, which will help the company reduce costs. Since COTCO does not play in the handset space, the acquisition reduces Cree's dependence on this end market, furthering its diversification strategy.
Management has outlined a specific cost reduction strategy. Currently, a lot of Cree's products are manufactured on 3-inch wafers, which raises the cost of manufacturing these products. The company has already started transitioning to 4-inch wafers, and intends to qualify the new products for 4-inch. Both the Schottky diode and LED chip transitions are on track, and the process is expected to be complete by the second half of the year. The INTRINSIC acquisition is expected to facilitate the development of these larger-diameter substrates. Additionally, management plans to shift a portion of the production process at the chip and packaging levels to low-cost regions in Asia. The COTCO facility is going to be used to manufacture some XLamp products, which will help increase shipments. Both these initiatives will lead to lower manufacturing costs, and help improve margins through fiscal 2007 and 2008. Cree follows an aggressive R&D strategy, which is currently focused on high-brightness products for the lighting market, high-power devices, as well as the development of larger wafers.
Cree's business is dependent on the success of its LED chips. However, while the demand for LEDs is likely to increase, prices are likely to weaken. LED prices have fallen in seven of the last eight quarters. The only reason for temporary increases in CREE s blended ASP is a mix shift to higher-ASP high brightness products. Management s R&D focus has been centered on the development of high-brightness chips for lighting applications. This, along with noticeable increase in demand for LED-based lighting applications, had a positive impact on ASPs in Q3. The flip side to the story is that the company is still in the early stages of the learning curve as far as high-brightness is concerned. This means that until it churns out significant volumes of the product, costs will continue to accelerate. Therefore, in the near-term, rising ASPs will be offset by increasing costs, so that gross margin expansion is marginal. Over the longer-term, costs will drop, volumes will ramp and ASPs will be on a decline. Management's long-term goal is to increase revenue by 60-70% over the next three years, with GAAP operating margins growing to the low-20% range. This could be a little too optimistic.
A large chunk of the company's LED business is generated in Japan. Competition in the Japanese market is heating up, with Nichia defending market share at the high-end, and Toyota Gosei making inroads into the low-end. Management expects the EZBright to provide some leverage at the high-end, and nearly half the LED chips are now manufactured on the EZBright platform.
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