Business Context and Reporting Period
This Form 10-Q covers Cree, Inc. (Note: Metadata listed "Wolfspeed," but the filing text identifies the registrant as Cree, Inc.) for the quarterly period ended December 25, 2005, and the six months ended on that date. The company develops and manufactures semiconductor materials and electronic devices made from silicon carbide (SiC) and gallium nitride (GaN). Effective December 25, 2005, the company discontinued its silicon-based RF and microwave semiconductor business (Cree Microwave), classifying it as a discontinued operation.
Key Financial Metrics
| Metric | Three Months Ended Dec 25, 2005 | Six Months Ended Dec 25, 2005 |
|---|---|---|
| Total Revenue | $105.6 million | $208.5 million |
| Gross Profit | $52.2 million | $104.4 million |
| Gross Margin | 49.4% | 50.1% |
| Net Income | $17.7 million | $39.4 million |
| Diluted EPS | $0.23 | $0.51 |
| Cash from Operations | N/A | $87.7 million |
| Cash & Investments | $338.3 million (Total) | $338.3 million (Total) |
| Debt | $0 | $0 |
Note: The company reported no debt outstanding as of December 25, 2005.
Material Changes vs. Prior Period
- Revenue Growth: Revenue from continuing operations increased 10% year-over-year for the quarter and 9% for the six-month period, driven by a 26% increase in LED unit shipments and growth in XLamp high-power packaged LEDs.
- Margin Compression: Gross margin decreased from 52.6% to 49.4% (quarterly) and 55.2% to 50.1% (six-month) compared to the prior year. This was primarily due to a 13% decline in blended average LED sales prices (due to competition) and the adoption of SFAS 123R, which added $1.2 million in stock-based compensation to cost of sales for the quarter.
- Operating Expenses: R&D expenses increased 44% and SG&A expenses increased 52% year-over-year for the quarter. Significant portions of these increases ($1.0M and $1.1M respectively) were attributable to the new stock-based compensation accounting standard.
- Discontinued Operations: The company recorded a net loss of $2.3 million for the quarter and $3.9 million for the six months related to the closure of the Cree Microwave business, including a $3.1 million charge for remaining lease obligations on the Sunnyvale facility.
Guidance, Outlook, and Risks
- Capital Expenditures: Management targets capital spending of $90.0 million to $110.0 million for fiscal 2006 to expand factory output, including the build-out of a new fabrication facility in Research Triangle Park, NC.
- Product Strategy: The company aims to increase the brightness of LED chips and expand sales of XLamp products in specialty lighting markets. They anticipate LED price declines of 3% to 5% in the third quarter of fiscal 2006.
- Accounting Changes: The adoption of SFAS 123R (Share-Based Payment) resulted in the first-time recognition of stock compensation expense, reducing net income by $6.3 million for the six-month period compared to prior accounting methods.
- Risks: Key risks include intense price competition in the LED market, reliance on a few large customers, potential delays in ramping up new production capacity, and the ongoing obligation to pay lease costs for the closed Sunnyvale facility through 2011 unless subleased.
Investor Verification Checklist
- Discontinued Operations: Verify the status of the Sunnyvale facility lease and the potential for subleasing to mitigate the $3.1 million accrued liability.
- Stock Compensation Impact: Assess the long-term impact of SFAS 123R on future margins, as stock-based compensation is now a recurring expense.
- Price Erosion: Monitor the trend of average selling prices (ASP) for LED chips against cost reductions from the migration to three-inch wafers.
- Customer Concentration: Review the dependency on major customers (e.g., Sumitomo) and the risk of order cancellations or inventory adjustments.
- Color Kinetics Investment: Note that fluctuations in the value of the Color Kinetics investment affect the deferred tax asset valuation allowance, causing volatility in reported income tax expense.