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CREE > SEC Filings for CREE > Form 10-Q on 22-Jan-2014All Recent SEC Filings

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Form 10-Q for CREE INC


22-Jan-2014

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Information set forth in this Quarterly Report on Form 10-Q contains various "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended (the Securities Act), and Section 21E of the Securities Exchange Act of 1934, as amended (the Exchange Act). All information contained in this report relative to future markets for our products and trends in and anticipated levels of revenue, gross margins and expenses, as well as other statements containing words such as "believe," "project," "may," "will," "anticipate," "target," "plan," "estimate," "expect" and "intend" and other similar expressions constitute forward-looking statements. These forward-looking statements are subject to business, economic and other risks and uncertainties, both known and unknown, and actual results may differ materially from those contained in the forward-looking statements. Any forward-looking statements we make are as of the date made, and except as required under the U.S. federal securities laws and the rules and regulations of the Securities and Exchange Commission (the SEC), we have no duty to update them if our views later change. These forward-looking statements should not be relied upon as representing our views as of any date subsequent to the date of this Quarterly Report. Examples of risks and uncertainties that could cause actual results to differ materially from historical performance and any forward-looking statements include, but are not limited to, those described in "Risk Factors" in Part II, Item 1A of this Quarterly Report.
The following discussion is designed to provide a better understanding of our unaudited consolidated financial statements, including a brief discussion of our business and products, key factors that impacted our performance and a summary of our operating results. The following discussion should be read in conjunction with the unaudited condensed consolidated financial statements and the notes thereto included in Part I, Item 1 of this Quarterly Report on Form 10-Q, and the consolidated financial statements and notes thereto and Management's Discussion and Analysis of Financial Condition and Results of Operations contained in our Annual Report on Form 10-K for the year ended June 30, 2013. Historical results and percentage relationships among any amounts in the financial statements are not necessarily indicative of trends in operating results for any future periods.
Overview
Cree, Inc. (Cree, we, our, or us) is a leading innovator of lighting-class light emitting diode (LED) products, lighting products and semiconductor products for power and radio-frequency (RF) applications. Our products are targeted for applications such as indoor and outdoor lighting, video displays, transportation, electronic signs and signals, power supplies, inverters and wireless systems.
We develop and manufacture semiconductor materials and devices primarily based on silicon carbide (SiC), gallium nitride (GaN) and related compounds. In many cases, the properties of SiC and GaN offer technical advantages over traditional silicon, gallium arsenide (GaAs) and other materials used for electronic applications.
Our LED products consist of LED components, LED chips and SiC materials. As LED technology improves, we believe the potential market for LED lighting will continue to expand. Our success in selling LED products depends upon our ability to offer innovative products and our ability to enable our customers to develop and market LED-based products that successfully compete against other LED-based products and drive LED adoption against traditional lighting products. Our lighting products consist of both LED and traditional lighting systems. We design, manufacture and sell lighting fixtures and lamps for the commercial, industrial and consumer markets.
In addition, we develop, manufacture and sell power and RF devices. Our power products are made from SiC and provide increased efficiency, faster switching speeds and reduced system size and weight over comparable silicon-based power devices. Our RF devices are made from GaN and provide improved efficiency, bandwidth and frequency of operation as compared to silicon or GaAs. The majority of our products are manufactured at our production facilities located in North Carolina, Wisconsin and China. We also use contract manufacturers for certain aspects of product fabrication, assembly and packaging. We operate research and development facilities in North Carolina, California, Wisconsin, India and China (including Hong Kong). Cree, Inc. is a North Carolina corporation established in 1987, and our headquarters are in Durham, North Carolina. Reportable Segments
As of December 29, 2013, we have three reportable segments:
LED Products

Lighting Products

Power and RF Products


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Reportable segments are components of an entity that have separate financial data that the entity's Chief Operating Decision Maker (CODM) regularly reviews when allocating resources and assessing performance. Our CODM is the Chief Executive Officer.
For financial results by reportable segment, please refer to Note 12 "Reportable Segments."
Industry Dynamics and Trends
There are a number of industry factors that affect our business which include, among others:

         Overall Demand for Products and Applications using LEDs. Our potential
          for growth depends significantly on the adoption of LEDs within the
          general lighting market and our ability to affect this rate of
          adoption. Although the market for LED lighting has grown in recent
          years, adoption of LEDs for general lighting is relatively new, still
          limited, and faces significant challenges before widespread adoption.
          Demand also fluctuates based on various market cycles, a continuously
          evolving LED industry supply chain, and demand dynamics in the market.
          These uncertainties make demand difficult to forecast for us and our
          customers.


         Intense and Constantly Evolving Competitive Environment. Competition in
          the LED and lighting industry is intense. Many companies have made
          significant investments in LED development and production equipment.
          Traditional lighting companies and new entrants are investing in
          LED-based lighting products as LED adoption has gained momentum.
          Traditional lighting companies have taken steps to try and limit access
          to their sales channels, including lighting agents and distributors.
          Product pricing pressures exist as market participants often undertake
          pricing strategies to gain or protect market share, increase the
          utilization of their production capacity and open new applications to
          LED-based solutions. To remain competitive, market participants must
          continuously increase product performance and reduce costs. To address
          these competitive pressures, we have invested in R&D activities to
          support new product development to deliver higher levels of performance
          and lower costs to differentiate our products in the market.


         Technological Innovation and Advancement. Innovations and advancements
          in LED, power and RF technologies continue to expand the potential
          commercial application for our products, particularly in the general
          illumination, power electronics and wireless markets. However, new
          technologies or standards could emerge, or improvements could be made
          in existing technologies, that could reduce or limit the demand for our
          products in certain markets.


         Regulatory Actions Concerning Energy Efficiency. Many countries have
          already instituted or have announced plans to institute government
          regulations and programs designed to encourage or mandate increased
          energy efficiency, even in some cases banning forms of incandescent
          lighting, which are advancing the adoption of more energy efficient
          lighting solutions such as LEDs. Government agencies are also involved
          in setting standards for LED lighting, which can affect market
          acceptance and the availability of rebates from government agencies or
          third parties such as utilities. While this trend is generally
          positive, these regulations are affected by changing political
          priorities and evolving technical standards which can modify or limit
          the effectiveness of these new regulations.


         Intellectual Property Issues. Market participants rely on patented and
          non-patented proprietary information relating to product development,
          manufacturing capabilities and other core competencies of their
          business. Protection of intellectual property is critical. Therefore,
          steps such as additional patent applications, confidentiality and
          non-disclosure agreements, as well as other security measures are
          generally taken. To enforce or protect intellectual property rights,
          litigation or threatened litigation commonly occurs.

Financial Results
The following is a summary of our financial results for the six months ended
December 29, 2013:

         Revenues increased to $806.1 million for the six months ended
          December 29, 2013 from $662.0 million for the six months ended
          December 30, 2012.


         For the six months ended December 29, 2013, gross margins improved to
          38.0% from 37.7% for the six months ended December 30, 2012. For the
          six months ended December 29, 2013, gross profit increased to $306.5
          million from $249.5 million for the six months ended December 30, 2012.


         Operating income increased to $72.2 million for the six months ended
          December 29, 2013 from $42.4 million for the six months ended
          December 30, 2012. Net income per diluted share increased to $0.54 for
          the six months ended December 29, 2013 from $0.31 for the six months
          ended December 30, 2012.


Table of Contents

         Combined cash, cash equivalents and short-term investments increased to
          $1.2 billion at December 29, 2013 compared to $1.0 billion at June 30,
          2013. Cash provided by operating activities was $168.0 million for the
          six months ended December 29, 2013, compared to $178.3 million for the
          six months ended December 30, 2012.


         Inventory increased to $234.5 million at December 29, 2013 compared to
          $197.0 million at June 30, 2013.

Business Outlook
We project that the markets for our products will remain highly competitive
during fiscal 2014. We anticipate focusing on the following key areas, among
others, in response to this competitive environment:
         Lead with innovation and drive to cost parity. We continue to work on
          developing new LEDs, LED lighting systems, and Power and RF devices to
          deliver improved value that approaches cost parity with existing
          technology and solutions. We believe that as our technology approaches
          cost parity, the market for these products will expand significantly.



         Build the Cree brand. We are working to build the Cree brand in both
          the commercial and consumer lighting segments by expanding our product
          offerings and continuing to invest in marketing the value of the Cree
          LED bulb and LED lighting directly to the end user. The level of
          investment will vary from quarter to quarter to optimize new product
          introductions, utility rebates, channel opportunities and seasonal
          trends.



         Focus on select market segments to drive LED adoption. In addition to
          our broad sales strategies, we are focused on a number of market
          segments where we can upgrade existing lighting and drive LED adoption
          with a combination of new product offerings, short payback, expanded
          services and innovative channel approaches.



         Translate product innovation into revenue and profit growth. We target
          revenue growth from new products and increased LED adoption and profit
          growth from the combination of higher sales, lower cost products and
          operating expense leverage.


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Results of Operations
The following table sets forth certain consolidated statement of income data for
the periods indicated (in thousands, except per share amounts and percentages):

                                        Three Months Ended                                             Six Months Ended
                            December 29,                   December 30,                   December 29,                   December 30,
                                2013                           2012                           2013                           2012
                      Dollars      % of Revenue      Dollars      % of Revenue      Dollars      % of Revenue      Dollars      % of Revenue
Revenue, net          $415,086           100 %       $346,286           100 %       $806,092           100 %       $662,039           100 %
Cost of revenue,
net                    259,308            62 %        212,810            61 %        499,557            62 %        412,514            62 %
Gross profit           155,778            38 %        133,476            39 %        306,535            38 %        249,525            38 %
Research and
development             44,436            11 %         39,941            12 %         86,179            11 %         77,488            12 %
Sales, general and
administrative          67,943            16 %         60,100            17 %        132,221            16 %        112,745            17 %
Amortization of
acquisition-related
intangibles              7,256             2 %          7,719             2 %         14,543             2 %         15,389             2 %
Loss on disposal or
impairment of
long-lived assets          760             - %            624             - %          1,417             - %          1,522             - %
Operating income        35,383             9 %         25,092             7 %         72,175             9 %         42,381             6 %
Non-operating
income, net              3,403             1 %          2,481             1 %          6,221             1 %          5,866             1 %
Income before
income taxes            38,786             9 %         27,573             8 %         78,396            10 %         48,247             7 %
Income tax expense       3,105             1 %          7,170             2 %         12,218             2 %         11,721             2 %
Net income             $35,681             9 %        $20,403             6 %        $66,178             8 %        $36,526             6 %
Basic earnings per
share                    $0.30                          $0.18                          $0.55                          $0.32
Diluted earnings
per share                $0.29                          $0.18                          $0.54                          $0.31

Revenues

Revenues for the three and six months ended December 29, 2013 and December 30,
2012 were comprised of the following (in thousands, except percentages):
                      Three Months Ended                                        Six Months Ended
                 December 29,     December 30,                            December 29,     December 30,
                     2013             2012               Change               2013             2012               Change
LED Products        $215,022         $200,962       $14,060        7 %       $433,045         $388,509        $44,536       11 %
Percent of
revenue                   52 %             58 %                                    54 %             59 %
Lighting
Products             173,656          122,714        50,942       42 %        321,574          230,787         90,787       39 %
Percent of
revenue                   42 %             35 %                                    40 %             35 %
Power and RF
Products              26,408           22,610         3,798       17 %         51,473           42,743          8,730       20 %
Percent of
revenue                    6 %              7 %                                     6 %              6 %
Total revenue       $415,086         $346,286       $68,800       20 %       $806,092         $662,039       $144,053       22 %

Our consolidated revenue increased 20% to $415.1 million for the three months ended December 29, 2013 from $346.3 million for the three months ended December 30, 2012. For the six months ended December 29, 2013, our consolidated revenue increased 22% to $806.1 million from $662.0 million for the six months ended December 30, 2012. This year-over-year increase is due to higher sales across all three of our business segments, but driven primarily by strong sales in the Lighting Products segment.


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LED Products Segment Revenue
LED Products revenue represents the largest portion of our revenue with 52% and 58% of our total revenues for the three months ended December 29, 2013 and December 30, 2012, respectively.
LED Products revenue increased 7% to $215.0 million for the three months ended December 29, 2013 from $201.0 million for the three months ended December 30, 2012, and 11% to $433.0 million for the six months ended December 29, 2013 from $388.5 million for the six months ended December 30, 2012. The increase in revenue was the result of an overall increase in the number of units sold, primarily from our newer products, partially offset by a decline in selling prices. The average selling prices for our LED products decreased for the three and six months ended December 29, 2013 as compared to the three and six months ended December 30, 2012 due primarily to market downward pricing pressure and sales of new lower cost products.
Lighting Products Segment Revenue
Lighting Products revenue represents 42% and 35% of our total revenues for the three months ended December 29, 2013 and December 30, 2012, respectively. Lighting Products revenue increased 42% to $173.7 million for the three months ended December 29, 2013 from $122.7 million for the three months ended December 30, 2012, and 39% to $321.6 million for the six months ended December 29, 2013 from $230.8 million for the six months ended December 30, 2012. The increase in revenue was the result of an overall increase in the number of units sold. The increased volume was partially offset by a reduction in selling prices primarily due to sales of new lower cost products. Power and RF Products Segment Revenue
Power and RF Products revenue represents 6% and 7% of our total revenues for the three months ended December 29, 2013 and December 30, 2012, respectively. Power and RF Products revenue increased 17% to $26.4 million for the three months ended December 29, 2013 from $22.6 million for the three months ended December 30, 2012, and 20% to $51.5 million for the six months ended December 29, 2013 from $42.7 million for the six months ended December 30, 2012. The increase in revenue was mainly the result of higher sales of RF products. The increased volume was partially offset by a reduction in selling prices primarily due to sales of new lower cost products. Unallocated Revenue
All of our revenue is allocated to our reportable segments. Our CODM does not review inter-segment revenue when evaluating performance and allocating resources to each segment, and inter-segment revenue is not included in the segment revenues presented above. As such, total segment revenue in the table above is equal to our consolidated revenue.


Table of Contents

Gross Profit and Gross Margin
Gross profit and gross margin for the three and six months ended December 29,
2013 and December 30, 2012 were comprised of the following (in thousands, except
percentages):
                           Three Months Ended                                        Six Months Ended
                      December 29,     December 30,                            December 29,     December 30,
                          2013             2012               Change               2013             2012               Change
LED Products gross
profit                    $97,644          $84,186       $13,458       16 %       $199,297         $159,653       $39,644       25 %
LED Products gross
margin                       45.4 %           41.9 %                                  46.0 %           41.1 %
Lighting Products
gross profit               48,426           41,383         7,043       17 %         88,244           75,483        12,761       17 %
Lighting Products
gross margin                 27.9 %           33.7 %                                  27.4 %           32.7 %
Power and RF
Products gross
profit                     15,321           12,798         2,523       20 %         28,777           23,220         5,557       24 %
Power and RF
Products gross
margin                       58.0 %           56.6 %                                  55.9 %           54.3 %
Unallocated costs          (5,613 )         (4,891 )        (722 )     15 %         (9,783 )         (8,831 )        (952 )     11 %
Consolidated gross
profit                   $155,778         $133,476       $22,302       17 %       $306,535         $249,525       $57,010       23 %
Consolidated gross
margin                       37.5 %           38.5 %                                  38.0 %           37.7 %

Our consolidated gross profit increased 17% to $155.8 million for the three months ended December 29, 2013 from $133.5 million for the three months ended December 30, 2012. Our consolidated gross margin decreased to 37.5% for the three months ended December 29, 2013 from 38.5% for the three months ended December 30, 2012.
LED Products Segment Gross Profit and Gross Margin LED Products gross profit increased 16% to $97.6 million for the three months ended December 29, 2013 from $84.2 million for the three months ended December 30, 2012 and gross margin increased to 45.4% for the three months ended December 29, 2013 from 41.9% for the three months ended December 30, 2012. For the six months ended December 29, 2013, LED Products gross profit increased $39.6 million to $199.3 million from $159.7 million for the six months ended December 30, 2012, and gross margin increased to 46.0% for the six months ended December 29, 2013 from 41.1% for the six months ended December 30, 2012. LED Products gross profit and gross margin increased due to higher revenue, factory cost reductions, the introduction of new lower cost products and higher factory utilization. These benefits more than offset the decline in the average selling prices for the three and six months ended December 29, 2013 as compared to the three and six months ended December 30, 2012. Lighting Products Segment Gross Profit and Gross Margin Lighting Products gross profit increased 17% to $48.4 million for the three months ended December 29, 2013 from $41.4 million for the three months ended December 30, 2012, and increased 17% to $88.2 million for the six months ended December 29, 2013 from $75.5 million for the six months ended December 30, 2012. Lighting Products gross margin decreased to 27.9% for the three months ended December 29, 2013 from 33.7% for the three months ended December 30, 2012, and decreased to 27.4% for the six months ended December 29, 2013 from 32.7% for the six months ended December 30, 2012. Lighting Products gross profit increased for both the three and six months ended December 29, 2013 as compared to the three and six months ended December 30, 2012 due to growth in LED lighting products sales. Lighting Products gross margin decreased for both the three and six months ended December 29, 2013 as compared to the three and six months ended December 30, 2012 primarily due to sales of our consumer LED bulb products, which had no sales in the comparable fiscal 2013 periods, and which have gross margins at the lower end of the range of our Lighting Products segment products' gross margins.
Power and RF Products Segment Gross Profit and Gross Margin Power and RF Products gross profit increased 20% to $15.3 million for the three months ended December 29, 2013 from $12.8 million for the three months ended December 30, 2012, and increased 24% to $28.8 million for the six months ended December 29, 2013 from $23.2 million for the six months ended December 30, 2012. Power and RF Products gross margin increased to 58.0% for the three months ended December 29, 2013 from 56.6% for the three months ended December 30, 2012 and increased to 55.9% for the six months ended December 29, 2013 from 54.3% for the six months ended December 30, 2012. These gross profit and gross margin increases were due primarily to higher revenue, factory cost reductions, increased factory utilization and introduction of new lower cost products. These benefits more than offset the decline in the average selling prices for the three and six months ended December 29, 2013 as compared to the three and six months ended December 30, 2012.


Table of Contents

Unallocated Costs
Unallocated costs were $5.6 million and $4.9 million for the three months ended December 29, 2013 and December 30, 2012, respectively. For the six months ended December 29, 2013 and December 30, 2012, unallocated costs were $9.8 million and $8.8 million, respectively. These costs consist primarily of manufacturing employees' stock-based compensation, expenses for profit sharing and quarterly or annual incentive plans and matching contributions under our 401(k) plan. These costs are not allocated to the reportable segments' gross profit because our CODM does not review them regularly when evaluating segment performance and allocating resources. The increase of $0.7 million for the three months ended December 29, 2013 and $1.0 million for the six months ended December 29, 2013 is primarily attributable to higher incentive and stock-based compensation incurred as a result of improved business performance in fiscal 2014 as compared to fiscal 2013.
For further information on the allocation of costs to segment gross profit, refer to Note 12 "Reportable Segments" in our consolidated financial statements included in Item 1 of this Quarterly Report. Research and Development
Research and development expenses include costs associated with the development of new products, enhancements of existing products and general technology research. These costs consist primarily of employee salaries and related compensation costs, occupancy costs, consulting costs and the cost of development equipment and supplies.
The following sets forth our research and development expenses in dollars and as a percentage of revenues (in thousands, except percentages):

                                 Three Months Ended                                        Six Months Ended
. . .
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