Cree shines bright as RFIC makers reap profits from handset frenzy

Phones with extra functionality are increasing the demand for GaAs-based power amplifiers, while features such as high-resolution cameras and video messaging require yet more LEDs. And with Strategy Analytics revising its 2004 forecast for handset sales from 586 million to 670 million, RFIC suppliers are set to make hay while the sun continues to shine.

Mixed messages surround any potential upturn in the infrastructure market. While the world s leading base-station builder, Ericsson, says that it believes this sector has finally turned the corner, a report from analyst company ABI Research concluded that this would not translate into positive news for suppliers of RF power chips and modules. ABI reckons that an inevitable slow-down in the deployment of GSM base stations will outweigh the roll-out of third-generation infrastructure, and that tough times lie ahead, especially for chip makers.

The pick of the bunch in terms of pure profit are Skyworks Solutions, which posted a net income of $13 m in its June quarter, and RF Micro Devices. The latter, which also predicts a boom in handset sales at the end of the year, made a net profit of only $3 m under

US GAAP accounting rules. However, in its pro forma accounts, which exclude some one-off charges, RFMD registered a net income of $12.7 m.

Another major GaAs IC manufacturer, TriQuint, reported its third consecutive profitable quarter - just. In terms of share price, the top three GaAs manufacturers have performed similarly over the past year; all are slightly down on their price this time last year, as investors ponder the prolonged success of what has become a very competitive market. Price erosion, which has been forced upon handset component suppliers as the market leaders Nokia and Motorola cut prices to compete with Korea s Samsung and LG, will make it increasingly difficult for the RFIC manufacturers to improve their profit margins - perhaps it is this that is holding back the stock prices.

CIBC World Markets analyst Earl Lum rates Skyworks as the most attractive proposition in this segment at the moment. "Skyworks Solutions remains our top pick among our RF component suppliers, as we believe the company is well positioned for additional market share growth over the next several quarters," he said, adding that Skyworks guidance for the September quarter exceeded that from its rival RFMD. Of TriQuint, Lum believes that continued softness in the opto segment will hamper its profitability, although the CIBC analyst foresees continued strength in wireless infrastructure through 2005.

Cree shines on Perhaps the brightest spot in the compound semiconductor portfolio is Cree, the vertically integrated LED and RF device maker (figure 1). In a typically bullish conference call, CEO Chuck Swoboda described "soaring" LED sales and Cree s plans to invest more than $100 m in fiscal 2005 to double its LED production capacity. The company is looking at expanding its existing sites or building new ones in the US or abroad.

Of course, Cree has every right to brag about its success: the company has seen its top-line revenue grow at an astonishing rate over the last four years, particularly when you consider the difficult economic climate of the past few years. Revenue has almost trebled from $109 m in fiscal 2000 to $307 m in the recently completed fiscal 2004 (figure 2).

In its guidance for the first quarter of its new fiscal year, which ends September 30, Cree predicted further revenue increases of 4-6%, while the bottom line is set to benefit as the company moves LED manufacturing from 2 inch to more cost-effective 3 inch production. This is expected to be completed within a year.

High-brightness LEDs comprise an increasingly large proportion of Cree s revenue, representing 54% of LED proceeds in the three months until June 30 - up from 50% in the previous quarter.

With its decision to invest heavily in ramping up LED production, plus its new focus on "replacing the light bulb" with a new range of LED products, Cree will inevitably incur some escalating costs, but if its revenue continues on the current growth pattern the record full-year profit of $58 m reported for fiscal 2004 will no doubt be eclipsed.

Lum and his colleagues at CIBC World Markets immediately slapped their approval on Cree s stock, upgrading earnings estimates for fiscal 2005. With Cree booked up to the hilt (85% of the September quarter guidance figure was booked at Cree s fiscal 2004 year-end, as compared with 65% the previous year) and producing LEDs at near 100% capacity, Lum commented: "We find the shares attractive and would accumulate at current levels." Lum has increased his revenue estimate for Cree to $431 m in fiscal 2005 and $594 m in fiscal 2006 (figure 2). If Cree gets close to that 2006 estimate it would seal a remarkable decade of growth, representing a 20-fold increase in revenue and a 30-fold increase in net income.

The recent quarter also saw the debut of LED-based lighting firm Color Kinetics on the Nasdaq. Its IPO, at $10 per share, gave the company a market capitalization of around $180 m, although the stock was down slightly at $9.88 as Compound Semiconductor went to press. CIBC acted as managing underwriter on the Color Kinetics IPO.

Fiber hope springs eternal How JDS Uniphase (JDSU) must envy the new darlings of the Nasdaq. But, like Cree, the company enjoyed its best bookings performance in recent history in the latest quarter - a hint that the long-awaited upturn in fiber optics has begun. JDSU has finally got its operations close to the break-even position, and with what it sees as "solid indicators" of market recovery, the company cheered the markets with its guidance of an 8-13% sequential increase in revenue. That sent JDSU shares sharply up, although, at $3.20 on August 26, they were still well down on the 2004 peak of almost $6 (figure 1). If the strong bookings performance turns out to mark an uptick in the sector, low-priced JDSU could be a stock worth tracking.

Also bouncing upwards on news of improved bookings were shares in Bookham Technology. Switching its fiscal year-end from December to June, the UK-based InP optical chip manufacturer fared better than had been expected after its guaranteed supply deal with Nortel Networks expired earlier in the year. Bookham now says that after an initial dip, demand from the Canadian system builder may return to historic levels, and it appears to have been this that sent the shares up by more than 10% initially. Like JDSU, however, Bookham s recent Nasdaq-listed share price of below $1 is way off its year high of around $3.40 back in February.

Of the other players in the fiber-optic segment, Emcore had a nightmarish quarter, registering a $5.3 m dent in its accounts thanks to problems with contaminated material from a supplier that resulted in $4 m of lost revenue from its transceiver product line. An additional $1.3 m spend was required to resolve the problem.

Still, the outlook for Emcore does at least make more comforting reading. Despite the problems with its transceivers, the company says that it has $10 m worth of purchase orders for this product line that will ship over the next two quarters. Revenue is set to increase 20% in the current quarter as a result.

Avanex, which swept up the optical components wings of Corning, Alcatel and Vitesse, is still accounting for those acquisitions, and reported a full-year revenue of $106.9 m for fiscal 2004, up $85.5 m on the previous year. Despite claiming to have "realized benefits from its manufacturing strategy", the Fremont, CA, company still has a huge amount of work to do before it can even approach profitability.

Operating costs far outstrip sales, with gross margin still heavily in the red. At the operating level, Avanex racked up a $22.6 m loss on sales of $31.9 m in the June quarter. Its guidance suggested a 10% bounce in the revenue figure for the September quarter, but Avanex would appear to need much more than simply the hope offered by JDSU s and Bookham s positive outlooks to comfort investors.

Still, Avanex s new CEO, Jo Major, appears to be in a positive frame of mind, and has set Avanex the goal of becoming the number-two supplier behind JDSU.