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Company Report

LED Supply Chain


July 8, 2010 | 13 Pages

CREE INC. (NNM: CREE) RATING: BUY


DOMINATING TECHNOLOGY & SHARE IN GENERAL Fiscal Year Ends Jun
LIGHTING - TODAY & TOMORROW - INITIATING COVERAGE
WITH A BUY Rating: Buy
 Sizing The General Lighting Market… The general lighting Price: Close $66.07
market is viewed as the “Holy Grail” for the LED industry Price Target: $112
because of its massive size and low levels of penetration. In 52-wk Range: $26.38-$83.38
2009, we estimate there were roughly 37 billion general lighting Market Capitalization (M): $7,175.3
sockets around the world and cumulative LED socket penetration Shares Outstanding (M): 108.6
at 0.34%. By 2015, we estimate cumulative LED socket Avg. Daily Vol. (000): 3,065.3
penetration will reach 13% which has significant implications for Enterprise Value: $5,632.5
LED unit volumes. We believe the LED market for general Consensus EPS Current Year: $1.67
lighting will increase from 409 million units in 2009 to more than Consensus EPS Next Year: $2.26
20 billion units in 2015, implying a CAGR of over 90%.
Insider Holdings: 4.3%
 Initiating Coverage With a Buy and $112 Target Price. Cree is Institutional Holdings: 85.1%
the technology and market share leader in LEDs for general % Float Interest: 11.5%
lighting, which accounts for more than 50% of its total sales.
Price/Book Value: 3.7x
Given the secular growth of LED adoption in general lighting, we
believe Cree should be able to grow its earnings in the range of
Andrew Huang
30%-40% over the next five years. By the end of 2011, we (415) 362-6143
believe the stock will be trading at 35x our CY12 EPS estimate of ahuang@sterneagee.com
$3.19, implying a price target of $112.
 A Big Fish In A Small Pond. In 2010, we believe 816 million
LEDs will be used for the general lighting “pond,” compared to
26 billion LEDs used for the backlighting “ocean.” However,
from 2010 through 2015, we estimate LED unit growth for
general lighting at 91% CAGR compared to backlighting at 39%.
With Cree’s estimated 25%-30% share of the faster growing
general lighting “pond” and a two year technology lead over its
peers, we believe Cree’s revenue growth will accelerate as the
“pond” becomes an “ocean.”

Earnings Summary
FYE Jun 2010E 2011E 2012E

EPS & P/E Summary


2010E 2010 Previous 2011E 2011 Previous 2012E 2012 Previous
EPS: Q1 $0.30 -- $0.53 -- $0.68 --
Q2 $0.38 -- $0.56 -- $0.73 --
Q3 $0.47 -- $0.56 -- $0.75 --
Q4 $0.50 -- $0.60 -- $0.81 --
Full Year $1.66 -- $2.26 -- $2.98 --
P/E Ratio: 39.7x -- 29.2x -- 22.2x --

Important Disclosures regarding Price Target Risks, Valuation Methodology, Regulation Analyst Certification,
Investment Banking, Ratings Definitions, and potential conflicts of interest begin on Page I of the Appendix Section.
800 Shades Creek Parkway Suite 700 Birmingham, AL 35209 205-949-3500
Sterne, Agee & Leach Inc. is Member NYSE, FINRA, SIPC
CREE INC. (NNM: CREE) July 8, 2010

INVESTMENT THESIS
We are initiating coverage of Cree with a Buy rating and a $112 target price. Our thesis
is simple. By year 2015, we believe that 22% of the market for lighting products will be
based on LED, which is far more conservative than the 50% estimate from Philips
Lighting. Based on our analysis, at that level of market adoption, we believe global
lighting socket penetration will reach 13% or 5.8 billion sockets out of 44.3 billion
worldwide. Our 2009 base case assumes a mere 0.35% penetration, which highlights not
only how early it is in the cycle, but also how much longer there is to go.

To achieve the 13% penetration by 2015 for general lighting implies a significant ramp in
LED unit volumes. Given our view that Cree is the market share and technology leader
in LEDs used in general lighting, we believe Cree should be able to grow its earnings in
the range of 30%-40% over the next five years, which is consistent with its five-year
historical average multiple of 36X forward 12 month EPS.

We believe that 18 months from now (the end of 2011), the stock will be trading at 35x
our CY12 EPS estimate of $3.19, implying a price target of $112. As is the case with any
high multiple stock, it is unlikely that it will straight-line to our target. Rather than
attempt to predict precise entry and exit points, we feel comfortable taking the long-term
view and believe that Cree’s leadership position in a secular growth industry will bring
the stock to our target and beyond.

INVESTMENT POSITIVES
General Lighting Presents Significant Volume Opportunities Over the Next 5 Years.
Based on our general lighting model shown in Exhibit 1 below, we believe LED unit
volumes for general lighting will grow at a 5-year CAGR of more than 90% between
2010 and 2015. Assuming ASP erosion of 20%-25% per year, this should translate to
industry revenue growth of 47% per year. As the market share leader for LEDs in
general lighting (we estimate Cree’s share at 25%-30%), we believe Cree has enormous
potential for revenue growth.

Exhibit 1. General Lighting Market (2009-2015)


CAGR
2009 2010 2011 2012 2013 2014 2015 '10-'15
GLOBAL LIGHTING SOCKETS (Units) 36,682 37,834 39,029 40,268 41,554 42,886 44,267 3%
Y/Y % - 3% 3% 3% 3% 3% 3%
Number of LED Sockets Exiting the Year (Units) 125 170 284 569 1,259 2,782 5,817 103%
Y/Y % - 36% 67% 101% 121% 121% 109%
Number of LED Sockets Added in the Year (Units) 18 45 113 286 690 1,523 3,035 132%
Y/Y % - 153% 149% 152% 141% 121% 99%
Average Number of LEDs/Socket 22.7 17.9 14.6 11.4 9.4 7.8 6.7 -18%
Y/Y % - -21% -19% -22% -18% -16% -14%
Total Number of LEDs (Units) 409 816 1,651 3,257 6,476 11,949 20,480 91%
Y/Y % - 100% 102% 97% 99% 85% 71%
Source: Sterne Agee estimates.

Dominant Share In General Lighting. We often hear bears talk about the competition
out of Asia taking share from Cree. At the 2010 Light + Building Show in Frankfurt, we
estimate that Cree had 35% share of the LED products on display. At the 2010 Lightfair
Show in Las Vegas, we estimate that Cree had 50% share of the LED products on
display. At the 2010 Guangzhou International Lighting Exhibition, we would not be
surprised if Cree had 30% share of the LED products on display. We believe Cree is
selling its LED products to all the major lighting companies around the world, whether it
is selling LED chips, LED components, or even, LED fixtures. We also believe Cree is
also selling its LED products to small startups seeking to enter the market. By selling to
both the established incumbents and new startups using LED technology to enter the
lighting market, Cree will benefit in either scenario.

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CREE INC. (NNM: CREE) July 8, 2010

Success in General Lighting Driven By Technology Leadership. Over the past three
years, Cree has made significant progress not only increasing the light output of its LEDs
but also improving its efficacy. The implication of higher efficacy is that an LED can
generate more light with less power, which results in greater energy savings. As recently
as 2006, the most common complaint about LED lighting was that the LEDs were still
not bright enough and that color stability was inconsistent. Today, we believe there are
few who would attempt to make that argument. We believe Cree’s pace of innovation
relative to its peers has enabled it to take share in general lighting. As an example,
Cree’s closest competitors are shipping LEDs with efficacies in the range of 100 lumens
per watt while Cree already has products commercially available at 130 lumens per watt.
Assuming LED brightness increases by about 15% a year, this implies that Cree is
about 2 years ahead of the industry average. As a result of this technology lead, as
shown in Exhibit 2 below, general lighting as a percentage of its sales has been steadily
increasing.

Exhibit 2. Cree – General Lighting as a Percentage of Total Sales Over Time


Lighting
10%

Other
30%

Other
50% Lighting
50%

Lighting
70%
Other
90%

FY07 FY09 FY11E


Source: Sterne, Agee estimates.

Secular Growth Offers Some Resistance to Recession. Despite the impact of a global
recession, Cree’s LED revenue increased 30% in 2008 (the stock dropped 42% versus the
NASDAQ down 40%) and 20% in 2009 (the stock increased 250% versus the NASDAQ
up 48%). We believe the revenue growth in those two difficult years is evidence that
LED adoption is secular.

Significant Investment in Channel Development and Marketing. We believe Cree


has made substantial investments in developing the channel for its LED components for
lighting over the past few years and will continue to do so in order to maintain its
leadership position in lighting. Since 2006, Cree has taken several steps to develop its
sales channel, including: 1) hiring Robert Pollock from Lumileds as senior vice president
of sales; 2) increasing its SG&A as a percentage of sales (8.4% in FY05, 9.5% in FY06,
12.2% in FY07, 14.2% in FY08, and 13.3% in FY09), which includes more advertising in
trade magazines and more marketing at trade shows; 3) adding Arrow, World Peace, and
Premier Farnell as distribution partners; and 4) launching the Cree solutions provider
network in 2008. For FY10E, we estimate SG&A as a percentage of sales will fall to
11%. While this may be good for margins, without enough new products and sales and
marketing expense, future revenue growth could become a risk. This is why we believe
Cree’s management has clearly stated its intention to gradually increase its operating
expenses (both R&D and SG&A) as a percentage of sales.

INVESTMENT CONCERNS
Technology – Will Cree Be Able To Sustain Its Leadership Position in General
Lighting? With several major electronics companies already committed to entering the
LED market (Samsung LED, LG Innotek, AUO, and Chi-Mei) and several others
currently evaluating the LED market (Panasonic, Toshiba, and Sharp), many investors
think that Cree will not be able to sustain its leadership position in general lighting. In
particular, we believe Samsung LED and Toshiba present the greatest risk to Cree, given
their substantial balance sheets and years of semiconductor manufacturing experience.

Page 3
CREE INC. (NNM: CREE) July 8, 2010

Our view is that this is a valid concern but not for another 3-5 years. We believe that: 1)
over the next three years, these competitors will be focused primarily on LEDs for
backlighting; 2) from the perspective of technology, it is significantly more difficult to
make an LED for general lighting than for backlighting (we estimate that Cree currently
has a 2 year technology advantage over its peers for general lighting); and 3) the lighting
market is much more fragmented than the computer or TV markets.

Litigation – A Forthcoming Litigation Nightmare? Nichia and Seoul Semiconductor


were involved in one of the most well-known litigation disputes in the LED industry.
The two companies sued and counter-sued one another in Korea, Taiwan, Japan, the
U.K., Germany, and the U.S. This started in January 2006 and concluded with a
settlement and cross-license in February 2009. LED volumes are now becoming
meaningful enough to attract many, large, new entrants. As a result, investors should be
aware that there is potential for an all-out war that could make Nichia/Seoul
Semiconductor look like a catfight. At issue is the intellectual property (related to LED
chip production, phosphors, and packaging), which is intimately held among the top-6
LED companies in the world, including Nichia, OSRAM, Cree, Philips Lumileds,
Toyoda Gosei, and Seoul Semiconductor. We would highlight Samsung LED and LG
Innotek as the two most likely to try and join the club.

Margins – Can Cree Sustain Its Margins as a Tsunami of New Capacity Comes On
Line? With Aixtron and Veeco estimated to ship between 700 and 800 tools in 2010,
there is a significant amount of new capacity coming on-line in 2011. Will Cree be able
to sustain its margins? This is a valid concern, but we think the answer is yes, because
while lower than normal ASP erosion clearly helps everyone in the industry, we think
Cree’s gross margin improvement has been driven by favorable mix shift, improving
yields, higher volumes, the transition from 3” to 4” wafers (which is now complete), and
to a lesser extent by more favorable pricing. Looking ahead, given that Cree’s gross
margins of 48% in the Mar-10 quarter are at the high end of its targeted range (mid- to
upper-40s), we think gross and operating margins could tick down over time. Our model
currently reflects operating income growth of 49% in FY11, and more than 30% in FY12
and FY13.

VALUATION
Over the past five years, Cree’s historical average P/E on NTM EPS is 36X, ranging from
20X at the low end to over 66X at the high end. Given our view that the lighting market
is at only 0.45% penetration in 2010, heading to 13% in 2015, we believe it is too early to
consider sustainable multiple compression. Instead, we would argue that the stock’s
current multiple on forward 12 month EPS is actually depressed and presents an excellent
entry point.

Exhibit 3. Cree – Historical P/E Multiple on Forward 12 Month EPS

70X
60X
50X
40X
30X
20X
10X
12/24/2005

12/24/2006

12/24/2007

12/24/2008

12/24/2009
6/24/2005

9/24/2005

3/24/2006

6/24/2006

9/24/2006

3/24/2007

6/24/2007

9/24/2007

3/24/2008

6/24/2008

9/24/2008

3/24/2009

6/24/2009

9/24/2009

3/24/2010

6/24/2010

P/NTM EPS AVG P/NTM EPS = 36X

Source: Sterne Agee estimates.

Page 4
CREE INC. (NNM: CREE) July 8, 2010

At $66, the stock is currently trading at 29X consensus EPS of $2.26 for FY11 (ending
June). Our target P/E multiple of 35X is consistent with our view that Cree should be
able to grow its earnings in the range of 30%-40% over the next five years. By the end of
2011, we believe the stock will be trading at 35X our CY12 EPS estimate of $3.19, which
suggests an 18 month target price of $112.

As is the case with any high multiple stock, it is unlikely that it will straight-line to our
target. Rather than attempt to predict precise entry and exit points, we feel comfortable
taking the long-term view and believe that Cree’s leadership position in a secular growth
industry will lead the stock to our price target and beyond.

Longer term, we see further upside to EPS as LED adoption in general lighting continues
along its multi-year upgrade cycle. By FY15, we do not think that EPS of more than
$7.00 is unreasonable (30%-35% growth on FY11 consensus EPS of $2.30), which
should translate to a stock price of over $200 by mid-2014. We believe the biggest risk
to our price target is general macro weakness. In 2008, the global recession
compressed multiples across the board. Fundamentals played out accordingly, with
Cree’s Mar-09 quarter revenue down Q/Q, the first down quarter in two years. Since
then, sequential revenue growth has resumed, with March-10 quarter revenue up 78%
Y/Y.

COMPANY OVERVIEW

Source: Company reports and Sterne Agee estimates.

As shown above, Cree is the most vertically integrated LED company in the industry,
making its own MOCVD tools, substrates, LED chips, LED components, and LED bulbs
and luminaires – everything but its own chip and packaging tools. Cree is also unique in
that it is the only LED chip company to grow its epi on silicon carbide – every other
company in the industry uses sapphire.

Cree started in the late 80s as a materials company focused on the development of silicon
carbide (SiC). Cree’s industry-leading blue and green LED chips are based on its
expertise in growing Gallium Nitride (GaN) and other materials on silicon carbide
substrates. In the 1990s, Cree sold its chips to LED packagers and benefited from the
adoption of LEDs in mobile phones and automobile dashboards. In 2004, Cree started its
XLamp product line, which used its LED chips in Cree’s own proprietary package. In
April 2007, Cree acquired COTCO, which expanded its product line for smaller,
packaged LEDs. In March 2008, Cree acquired LED Lighting Fixtures (LLF), which
further expanded its product line into LED-based light fixtures. Today, Cree enjoys a
leadership position in all of its different product families, including LED chips, LED
packages or components, and LED fixtures.

Customers. In fiscal 2009 (ended June), Seoul Semiconductor accounted for 13% of
sales, Arrow Electronics accounted for 11% of sales, and Sumitomo, historically a 10%
customer, accounted for 8% of total sales. Sumitomo serves as a distributor for Cree’s
customers in Japan, some of which include Stanley Electric, Rohm, and Citizen
Electronics. Seoul Semiconductor and Sumitomo’s customers manufacture LED
packages or components with LED chips purchased from Cree. Given that Cree is
focused on keeping its chip business stable and growing the components and LLS
businesses, we expect Cree’s current customer concentration to decrease over time.

Cree sells its LED components to manufacturers of lighting fixtures, lighting engines, and
bulbs. In the future, we would not be surprised to see new 10% customers, which could
include Asian contract manufacturers which manufacture LED bulbs for some of the
biggest names in the lighting industry. Arrow is one of the world’s largest semiconductor
distributors in the world and primarily sells Cree’s XLamps. For its LED Lighting

Page 5
CREE INC. (NNM: CREE) July 8, 2010

Solutions products, Cree’s customers include electrical wholesalers, lighting showrooms,


lighting specifiers (designers or engineers who specify lighting for a home, building, or
project), electrical contractors, and national home builders.

Competition – LED Chips. Cree’s primary competition is Nichia, which primarily uses
its chips for its own LED packages. However, we believe Nichia sells some of its chips
to other packaging customers in Japan, who in turn compete with Nichia’s LED
packages. Cree’s LED chip competitors are primarily Epistar (based in Taiwan), and
Toyoda Gosei (based in Japan). Cree’s LED chips lead the industry with respect to
brightness, reliability, and color consistency.

Competition – LED Components (High Brightness LEDs and XLamps). Cree’s


competitors for LED components include Nichia, Osram (Siemens), Citizen, Stanley
Electric, Lumileds (Philips), Avago, Everlight, Rohm, Toyoda Gosei, Seoul
Semiconductor, and Samsung LED. Cree’s LED components lead the industry with
respect to brightness, efficacy, reliability, and color consistency. Of these competitors,
we believe Cree is most watchful of Nichia, the LED market share leader with about
20%-25% market share.

Competition – LLS (LED Lighting Solutions). There are many LED fixtures in the
market, however, from the perspective of color and efficacy, few are able to compete
with fixtures made with Cree’s TrueWhite technology. Some competitors are the largest,
traditional lighting fixture manufacturers in the world, all of which are in the middle of
transitioning to LED technology. These include Acuity Brands, Cooper Lighting, and
Hubbell in the US, Zumtobel, Philips, and Schneider Electric in Europe, and Toshiba,
Sharp, Panasonic, and Iwasaki Electric in Japan, as well as hundreds of others around the
world. Other competitors include new entrants to the lighting fixture market that have
focused on LED-based products, like BETA LED, Nexxus Lighting, and Lighting
Science Group. Lastly, LLS will also compete with makers of LED-based bulbs, some of
which include Philips, GE, and Sylvania, as well as newcomers like CRS Electronics,
LEDengin, and Nexxus Lighting. There are countless others, though we would highlight
that among the ones tested by the Department of Energy, many demonstrate lumen output
at roughly half the manufacturer’s claims.

PRODUCT OVERVIEW
CREE Revenue Breakdown by Product (FY09) CREE Revenue Breakdown by End Market (FY09) CREE Revenue Breakdown by Geography (FY09)

Non-LED Other Malaysia Taiwan Other


Revenue 3% 3% 2%
5%
11% Japan
Handsets
10% 9%
LED Chips
29% Hong Kong &
LLS China
6% Backlighting 38%
10%
Europe
10%
Lighting
50%

XLamps Korea
31% 15%
High Video
Brightness Screens
LEDs 25%
23% United States
20%

Source: Company reports.

LED Components (51% of FY09 sales, 56% of FY10E sales). LED components
includes the power LEDs (the XLamp product family used primarily for general lighting)
and high brightness LEDs (products typically used in digital signs and scoreboards).
Power LEDs are characterized by their large die size (at least 1 mm x 1 mm, or roughly
10x the size of a high brightness LED) and generate a significant amount of light
compared to a high brightness LED.

Page 6
CREE INC. (NNM: CREE) July 8, 2010

LED Chips (32% of FY09 sales, 27% of FY10E sales). Cree also manufactures LED
chips based on silicon carbide technology, while the rest of the LED industry uses
sapphire to manufacture LED chips. Cree currently uses silicon carbide because it
believes it can manufacture the brightest chips with that substrate. We believe Cree’s
scientists are not necessarily married to any technology. Chips range in size from 0.2
mm x 0.2 mm to 1.4 mm x 1.4 mm. The larger sized chips (> 1 mm x 1 mm) are used in
power LEDs. Blue LED chips are coated with a yellow phosphor in order to create white
light. Cree will participate in the shift to LED backlighting for LCD notebooks, TVs, and
monitors through its LED chips, which are sold to packagers like LG Innotek, Seoul
Semiconductor, Lite-On, and others.

LED Lighting Solutions (4% of FY09 sales, 6% of FY10E sales). Through its
acquisition of LLF (LED Lighting Fixtures), Cree’s LED-based fixtures have led the
industry with respect to brightness and efficacy for the past two years. Patented color
mixing technology enables efficacies and a color rendering index (CRI) that are
significantly higher than those of competitors, which rely on standalone, warm-colored
LEDs.

Silicon Carbide Wafers (4% of FY09 sales, 3% of FY10E sales). Cree manufactures
silicon carbide wafers and typically sells the wafers to companies that use them to make
high power switching and microwave devices used in military applications. We believe
silicon carbide is an ideal substrate for applications (such as military) exposed to high
temperatures and radiation. Wafers are produced in 2 inch, 3 inch, and 4 inch sizes.

Other (4% of FY09 sales, 8% of FY10E sales). Cree also manufactures Schottky
diodes, which are used by power supply manufacturers to improve efficiency. Also
included in Other is government R&D work.

Page 7
CREE INC. (NNM: CREE) July 8, 2010

Cree Inc. Quarterly Income Statement


Jun-10 Fiscal Sep-10 Dec-10 Mar-11 Jun-11 Fiscal Sep-11 Dec-11 Mar-12 Jun-12 Fiscal Sep-12 Dec-12 Mar-13 Jun-13 Fiscal
Q4E 2010 Q1E Q2E Q3E Q4E 2011E Q1E Q2E Q3E Q4E 2012E Q1E Q2E Q3E Q4E 2013E
LED Revenue $234.692 $784.935 $257.861 $283.913 $292.090 $325.905 $1,159.769 $372.442 $414.139 $424.648 $472.721 $1,683.951 $526.717 $569.456 $582.650 $631.170 $2,309.994
Q/Q % 11% - 10% 10% 3% 12% - 14% 11% 3% 11% - 11% 8% 2% 8% -
Y/Y % 73% 52% 65% 56% 38% 39% 48% 44% 46% 45% 45% 45% 41% 38% 37% 34% 37%
% of total 90% 91% 91% 91% 91% 92% 91% 93% 93% 93% 93% 93% 94% 94% 94% 95% 94%
Non-LED Revenue 25.550 77.894 26.192 26.870 27.826 28.842 109.729 30.187 31.629 33.171 34.822 129.809 35.243 35.678 36.127 36.589 143.637
Q/Q % 15% - 3% 3% 4% 4% - 5% 5% 5% 5% - 1% 1% 1% 1% -
Y/Y % 115% 56% 108% 54% 25% 13% 41% 15% 18% 19% 21% 18% 17% 13% 9% 5% 11%
% of total 10% 9% 9% 9% 9% 8% 9% 7% 7% 7% 7% 7% 6% 6% 6% 5% 6%
Revenue $260.242 $862.829 $284.053 $310.783 $319.916 $354.747 $1,269.499 $402.630 $445.768 $457.819 $507.543 $1,813.760 $561.961 $605.134 $618.776 $667.760 $2,453.631
Cost of goods sold 135.744 456.353 148.448 162.728 167.830 186.458 665.464 211.625 235.190 242.007 268.799 957.621 298.180 322.299 330.184 356.989 1,307.652
% of sales 52.2% 52.9% 52.3% 52.4% 52.5% 52.6% 52.4% 52.6% 52.8% 52.9% 53.0% 52.8% 53.1% 53.3% 53.4% 53.5% 53.3%
Gross profit 124.498 406.476 135.605 148.055 152.086 168.289 604.034 191.005 210.577 215.813 238.744 856.139 263.780 282.835 288.593 310.770 1,145.978
% of sales 47.8% 47.1% 47.7% 47.6% 47.5% 47.4% 47.6% 47.4% 47.2% 47.1% 47.0% 47.2% 46.9% 46.7% 46.6% 46.5% 46.7%
R&D 21.429 77.705 23.674 26.834 28.582 32.758 111.848 37.180 41.609 42.276 46.868 167.933 52.455 57.090 57.758 62.330 229.633
% of sales 8.2% 9.0% 8.3% 8.6% 8.9% 9.2% 8.8% 9.2% 9.3% 9.2% 9.2% 9.3% 9.3% 9.4% 9.3% 9.3% 9.4%
SG&A 27.859 94.166 30.692 34.202 35.847 40.459 141.200 46.323 51.732 52.672 58.901 209.627 65.778 71.436 72.428 78.829 288.471
% of sales 10.7% 10.9% 10.8% 11.0% 11.2% 11.4% 11.1% 11.5% 11.6% 11.5% 11.6% 11.6% 11.7% 11.8% 11.7% 11.8% 11.8%
Loss on disposal of assets 0.750 4.439 0.750 0.750 0.750 0.750 3.000 0.750 0.750 0.750 0.750 3.000 0.750 0.750 0.750 0.750 3.000
% of sales 0.3% 0.5% 0.3% 0.2% 0.2% 0.2% 0.2% 0.2% 0.2% 0.2% 0.1% 0.2% 0.1% 0.1% 0.1% 0.1% 0.1%
Operating income 74.460 230.166 80.489 86.269 86.907 94.322 347.987 106.752 116.487 120.114 132.226 475.579 144.798 153.559 157.656 168.861 624.874
% of sales 28.6% 26.7% 28.3% 27.8% 27.2% 26.6% 27.4% 26.5% 26.1% 26.2% 26.1% 26.2% 25.8% 25.4% 25.5% 25.3% 25.5%
Other income (expense) 2.169 8.060 2.169 2.169 2.169 2.169 8.676 2.219 2.269 2.319 2.369 9.176 2.419 2.469 2.519 2.569 9.976
Pretax income 76.629 238.226 82.658 88.438 89.076 96.491 356.663 108.971 118.756 122.433 134.595 484.755 147.217 156.028 160.175 171.430 634.850
% of sales 29.4% 27.6% 29.1% 28.5% 27.8% 27.2% 28.1% 27.1% 26.6% 26.7% 26.5% 26.7% 26.2% 25.8% 25.9% 25.7% 25.9%
Income taxes (benefit) 21.456 64.203 23.144 24.763 24.941 27.018 99.866 29.967 32.658 33.669 37.014 133.308 39.748 42.128 43.247 46.286 171.409
Tax rate 28.0% 27.0% 28.0% 28.0% 28.0% 28.0% 28.0% 27.5% 27.5% 27.5% 27.5% 27.5% 27.0% 27.0% 27.0% 27.0% 27.0%
Net income, excluding one-time items $55.173 $174.023 $59.514 $63.675 $64.135 $69.474 $256.797 $79.004 $86.098 $88.764 $97.581 $351.447 $107.468 $113.900 $116.928 $125.144 $463.440
Diluted shares 110.700 104.660 111.807 112.925 114.054 115.195 113.495 116.347 117.510 118.685 119.872 118.104 121.071 122.282 123.504 124.740 122.899
Diluted EPS, excluding one-time items $0.50 $1.66 $0.53 $0.56 $0.56 $0.60 $2.26 $0.68 $0.73 $0.75 $0.81 $2.98 $0.89 $0.93 $0.95 $1.00 $3.77

Calendar 2010E Y/Y% Calendar 2011E Y/Y% Calendar 2012E Y/Y%


Sales $1,089.2 68% Sales $1,523.1 40% Sales $2,132.5 40%
EBITDA $384.8 95% EBITDA $484.5 26% EBITDA $630.7 30%
Diluted EPS $2.06 108% Diluted EPS $2.57 25% Diluted EPS $3.38 32%

Diluted EPS % Change (Q/Q) 6% 6% 6% 0% 7% 13% 7% 3% 8% 10% 4% 2% 5%


Diluted EPS % Change (Y/Y) 178% 152% 77% 47% 19% 20% 36% 28% 30% 34% 35% 32% 31% 27% 27% 23% 27%
Sales % Change (Q/Q) 11% 9% 9% 3% 11% 13% 11% 3% 11% 11% 8% 2% 8%
Sales % Change (Y/Y) 76% 53% 68% 56% 37% 36% 47% 42% 43% 43% 43% 43% 40% 36% 35% 32% 35%
EBITDA 94.5 304.9 100.5 106.3 106.9 114.3 428.0 126.8 136.5 140.1 152.2 555.6 164.8 173.6 177.7 188.9 704.9
EBITDA % Change (Q/Q) 13% 6% 6% 1% 7% 11% 8% 3% 9% 8% 5% 2% 6%
EBITDA % Change (Y/Y) 140% 110% 87% 45% 28% 21% 40% 26% 28% 31% 33% 30% 30% 27% 27% 24% 27%
Days Sales Outstanding (DSOs) - - - - - - - - - - - - -
Inventory Turns - - - - - - - - - - - - -
Days Inventory - - - - - - - - - - - - -
ROA % (LTM) - - - - - - - - - - - - -
ROE % (LTM) - - - - - - - - - - - - -
Source: Company reports and Sterne Agee estimates.

Page 8
CREE INC. (NNM: CREE) July 8, 2010

LED Supply Chain Comps


PRICE* MARKET CALENDAR EPS* EPS GROWTH P/E LTM P/LTM
COMPANY NAME TICKER Rating CCY 07/08/10 CAP** 2009 2010 2011 2010 2011 2010 2011 SALES** Sales BVPS P/BOOK
CREE CREE BUY USD 66.07 6,552 0.98 2.06 2.48 110% 20% 32.1 26.6 750 8.7 17.73 3.7
AIXTRON AIXA-ETR BUY USD 21.90 2,760 0.49 1.77 2.29 259% 29% 12.3 9.6 435 6.4 4 4.9
VEECO INSTRUMENTS VECO BUY USD 37.59 1,379 7.91 68.99 65.87 772% -5% 0.5 0.6 380 3.6 10 3.7
RUBICON TECHNOLOGY RBCN - USD 32.51 613 0.61 1.15 1.50 - - - 21.7 20 30.9 4.91 6.6
SEOUL SEMICONDUCTOR 046890-KR BUY KRW 42,250 1,962 554 1,468 2,468 165% 68% 28.8 17.1 497 4.0 9,500 4.4
SEMCO / Samsung LED 009150-KR - KRW 147,500 8,862 7,295 8,436 9,928 16% 18% 17.5 14.9 4,767 1.9 28,084 5.3
LG INNOTEK 011070-KR - KRW 160,000 2,302 9,333 12,726 18,176 36% 43% 12.6 8.8 1,915 1.2 43,366 3.7
LUMENS 038060-KR - KRW 12,200 390 719 1,100 - 53% - 11.1 - 114 3.4 2,205 5.5
EPISTAR 2448-TW - TWD 89.50 2,079 5.40 6.00 6.65 11% 11% 14.9 13.5 402 5.2 47.64 1.9
EVERLIGHT 2393-TW - TWD 93.20 1,168 6.46 7.08 8.04 10% 14% 13.2 11.6 357 3.3 36.66 2.5
GROUP AVERAGE 159% 25% 15.9 13.8 6.9 4.2
* in local currency
** USD in millions
Source: Company reports and Sterne Agee estimates.

Page 9
CREE INC. (NNM: CREE) July 8, 2010

LED SUPPLY CHAIN 2009 Total Sales Market Cap


Company Ticker Offering (US$ millions) (US$ millions)
Materials
Rubicon RBCN-US sapphire substrates $20 $514
Kyocera 6971-JP sapphire substrates $10,573 $15,442
Universal Display PANL-US organic LED materials $16 $674
Capital Equipment
Aixtron AIXA-DE MOCVD reactors $435 $2,471
Veeco Instruments VECO-US MOCVD reactors $380 $1,310
Taiyo Nippon Sanso 4091-JP MOCVD reactors $4,561 $3,071
Jusung Engineering 036930-KR MOCVD reactors $146 $527
Applied Materials AMAT-US MOCVD reactors $5,357 $16,374
Disco 6146-JP Laser dicers, grinders and polishers $509 $2,331
TOWA 6315-JP Molding equipment for LED packages $119 $199
Shinkawa 6274-JP LED packaging - wire bonders and die bonders $75 $260
ASM Pacific 522-HK LED packaging - wire bonders $610 $3,044
Kulicke & Soffa KLIC-US LED packaging - wire bonders $316 $462
Agilent Technologies A-US LED packaging - test $4,512 $10,277
LED IP
Rambus RMBS-US LED IP $113 $2,084
LED Chips and Components
Avago Technologies AVGO-US LED components $2,099 $5,008
Vishay Intertechnology VSH-US LED components $2,042 $1,579
Cree CREE-US silicon carbide substrates, LED chips, LED components, LED lighting
$648 fixtures $6,475
Micron Technology MU-US LED chips, LED components $5,464 $7,299
SEMCO / Samsung LED 009150-KR LED chips, LED components $4,767 $8,573
LG Innotek 011070-KR LED chips, LED components $2,610 $2,363
Seoul Semiconductor 046890-KR LED chips, LED components $621 $1,981
Lumens 038060-KR LED components $114 $380
EpiValley 068630-KR LED chips - $105
Lumimicro 082800-KR LED components - -
AU Optronics AUO-US LED chips, LED components $10,913 $7,596
Lite-On 2301-TW LED components, LED lighting fixtures $5,817 $2,435
Chimei Innolux 3481-TW LED chips, LED components $5,150 $7,608
Epistar 2448-TW LED chips $402 $1,945
Everlight 2393-TW LED components $357 $1,056
Opto Tech 2340-TW LED chips $184 $383
Unity Opto 2499-TW LED components, LED lighting fixtures $149 $437
I-Chiun Precision 2486-TW LED lead frames $139 $271
Harvatek 6168-TW LED components $85 $194
Tekcore 3339-TW LED chips $80 $223
Huga Optotech 8199-TW LED chips $71 $227
Formosa Epitaxy 3061-TW LED chips $67 $423
Genesis Photonics 3383-TW LED chips $35 $172
Sanan Optoelectronics 600703-SS LED chips - -
Toshiba 6502-JP LED components $68,066 $20,882
Panasonic 6752-JP LED components $71,821 $25,884
Sharp Electronics 6753-JP LED components $27,376 $11,224
Showa Denko 4004-JP LED chips $7,285 $2,771
Toyoda Gosei 7282-JP LED chips, LED components $4,670 $3,330
Rohm 6963-JP LED components $3,497 $6,470
Citizen Electronics 7762-JP LED components $2,569 $1,839
Stanley Electric 6923-JP LED components $2,329 $3,047
Source: Company reports and Sterne Agee estimates.

Page 10
CREE INC. (NNM: CREE) July 8, 2010

APPENDIX SECTION
Company Description: Cree manufactures its own MOCVD tools, substrates, LED chips, LED components, and LED bulbs and
luminaires. Cree is the only LED company that grows its epi on silicon carbide rather than sapphire. Its blue and green LED chips
are based on expertise growing Gallium Nitride (GaN) and other materials on silicon carbide substrates. Cree's products are used in
general lighting (50%), video screens (25%), backlighting (10%), handsets (10%), and other (5%) applications. As a result of its
technology leadership, Cree has #1 market share in LEDs for general lighting.

IMPORTANT DISCLOSURES:
Price Target Risks & Related Risk Factors:
With several major electronics companies already committed to entering the LED market (Samsung LED, LG Innotek, AUO, and Chi-
Mei) and several others currently evaluating the LED market (Panasonic, Toshiba, and Sharp), many investors think that Cree will not
be able to sustain its leadership position in general lighting. In particular, we believe Samsung LED and Toshiba present the greatest
risk to Cree, given their substantial balance sheets and years of semiconductor manufacturing experience.

Our view is that this is a valid concern but not for another 3-5 years. We believe that: 1) over the next three years, these competitors
will be focused primarily on LEDs for backlighting; 2) from the perspective of technology, it is significantly more difficult to make an
LED for general lighting than for backlighting (we estimate that Cree currently has a 2 year technology advantage over its peers for
general lighting); and 3) the lighting market is much more fragmented than the computer or TV markets.

Valuation Methodology:
Over the past five years, Cree's historical average P/E on NTM EPS is 36X, ranging from 20X at the low end to over 66X at the high
end. Given our view that the lighting market is at only 0.45% penetration in 2010, heading to 13% in 2015, we believe it is too early
to consider sustainable multiple compression. Instead, we would argue that the stock's current multiple on forward 12 month EPS is
actually depressed and presents an excellent entry point.

At $66, the stock is currently trading at 29X consensus EPS of $2.26 for FY11 (ending June). Our target P/E multiple of 35X is
consistent with our view that Cree should be able to grow its earnings in the range of 30%-40% over the next five years. By the end of
2011, we believe the stock will be trading at 35X our CY12 EPS estimate of $3.19, which suggests an 18 month target price of $112.

Regulation Analyst Certification:


I, Andrew Huang, (415) 362-6143, hereby certify the views expressed in this research report accurately reflect my personal views
about the subject security(ies) or issuer(s). I further certify that no part of my compensation was, is, or will be, directly or indirectly,
related to the specific recommendations or views expressed by me in this report.

Sterne, Agee & Leach, Inc. Disclosure Legend as of July 8, 2010:

Company Disclosure(s) – See Below


Aixtron AG (AIXA-ETR - XETRA): None
Cree Inc. (CREE - NNM): 1
General Electric Co. (GE - NYSE): 1
Seoul Semiconductor Co., Ltd. (046890-KRX - KOSDAQ): None
Siemens AG (SIE.DE - NNM): None
Veeco Instruments (VECO - NNM): 1

1. Sterne, Agee & Leach, Inc. makes a market in the shares of the subject company.
2. Sterne, Agee & Leach, Inc. has, over the past 12 months, managed or co-managed a public securities offering or
provided other investment banking services for the subject company.
3. Sterne, Agee & Leach, Inc. has various security accounts open for the subject company.
4. Sterne, Agee & Leach, Inc. provides administration for 401(k) plans for the subject company.
5. Sterne Agee Financial Services, Inc. has clearing agreements with the subject company.
6. The Sterne Agee analyst who has active coverage on this company owns a position in the subject company.
7. Sterne, Agee & Leach, Inc. or its affiliates beneficially own 1% or more of any class of common equity securities of the
subject company.

Sterne, Agee & Leach, Inc.’s research analysts receive compensation that is based upon various factors, including Sterne, Agee &
Leach, Inc.’s total revenues, a portion of which is generated by investment banking activities.
Appendix Section, Page I
CREE INC. (NNM: CREE) July 8, 2010

Definition of Investment Ratings:


BUY: We expect this stock to outperform the industry over the next 12 months.
NEUTRAL: We expect this stock to perform in line with the industry over the next 12 months.
SELL: We expect this stock to underperform the industry over the next 12 months.
RESTRICTED: Restricted list requirements preclude comment.

Ratings Distribution:
Of the securities rated by Sterne, Agee & Leach, Inc., as of June 30, 2010, 48.7% had a BUY rating, 49.9% had a NEUTRAL rating,
1.4% had a SELL rating, and 0% was RESTRICTED. Within those ratings categories, 2.04% of the securities rated BUY, 1.94%
rated NEUTRAL, 0% rated SELL, and 0% rated RESTRICTED received investment banking services from Sterne, Agee & Leach,
Inc., within the 12 months preceding June 30, 2010.

ADDITIONAL INFORMATION AVAILABLE UPON REQUEST: Contact Robert Hoehn at 1-212-338-4731.


Other Disclosures:
Opinions expressed are our present opinions only. This material is based upon information that we consider reliable, but we do not
represent that it is accurate or complete, and it should not be relied upon as such. Sterne, Agee & Leach, Inc., its affiliates, or one or
more of its officers, employees, or consultants may, at times, have long or short or options positions in the securities mentioned herein
and may act as principal or agent to buy or sell such securities.

Copyright © 2010 Sterne, Agee & Leach, Inc. All Rights Reserved.

Sterne, Agee & Leach, Inc. disclosure price charts are updated within the first fifteen days of each new calendar quarter per FINRA
regulations. Price charts for companies initiated upon in the current quarter, and rating and target price changes occurring in the
current quarter, will not be displayed until the following quarter.

Price Chart(s):

To receive price charts or other disclosures on the companies mentioned in this report, please contact Sterne, Agee & Leach, Inc. toll-
free at (800) 240-1438 or (205) 949-3689.

Appendix Section, Page II


STERNE, AGEE & LEACH, INC.
Founded in 1901, Sterne Agee has been providing investors like you with high-quality investment opportunities for
over a century. During the early years, our founders prominently established themselves in the financial securities
industry in the southeastern United States. Today, we have expanded to serve all regions of the country. Sterne,
Agee is headquartered in Birmingham, Alabama with offices in 22 states including Alabama, Arkansas, California,
Florida, Georgia, Illinois, Kentucky, Louisiana, Maine, Massachusetts, Minnesota, Mississippi, Missouri, New Jersey, New York,
North Carolina, Pennsylvania South Carolina, Tennessee, Texas, Virginia, and Wisconsin. Sterne Agee is one of the largest
independent firms in the country. Sterne, Agee & Leach, Inc. is a division of Sterne Agee Group, Inc., which also includes The Trust
Company of Sterne, Agee & Leach, Inc.; Sterne Agee Asset Management, Inc.; Sterne Agee Clearing, Inc.; and Sterne Agee Financial
Services, Inc.—www.sterneagee.com
EQUITY CAPITAL MARKETS ADMINISTRATION
Ryan Medo Managing Dir., Eq. Cap. Mkts. (205) 949-3623 David Lee Director, Equity Products (205) 949-3689
Robert Lake Vice President (205) 949-3624 Yan Chao Associate (205) 949-3622
Chuck Carlisle Sr. Portfolio Analyst (205) 949-3571

EQUITY RESEARCH
Robert Hoehn Director of Research (212) 338-4731

CONSUMER FINANCIAL SERVICES (CONT.)


Apparel Retailing & Toys Mortgage Finance & Specialty Finance
Margaret Whitfield SVP, Sr. Analyst (973) 519-1019 Henry J. Coffey, Jr., CFA SVP, Sr. Analyst (615) 760-1472
Jennifer Milan VP, Sr. Analyst (212) 763-8211 Jason Weaver Analyst (615) 760-1475
Jessica Gerberi Associate (212) 338-4784
Property/Casualty Insurance
Educational Services / Interactive Entertainment Dan Farrell Mng. Dir. (212) 338-4782
Arvind Bhatia, CFA Mng. Dir. (214) 702-4001 Nitin Chhabra Associate (212) 338-4779
Luke Shagets Analyst (214) 702-4030
GLOBAL INDUSTRIAL INFRASTRUCTURE (GII)
Footwear & Apparel
Sam Poser SVP, Sr. Analyst (212) 763-8226 ACME &Latin America
Kenneth M. Stumphauzer Sr. Analyst (212) 763-8287 Lawrence T. De Maria, CFA Director (212) 338-4704
Ben Elias, CFA SVP, Sr. Analyst (212) 338-4706
Leisure & Entertainment
David Bain Mng. Dir. (949) 721-6651 Building, Power & Water Infrastructure
Sherry Yin Associate (949) 721-6651 Michael J. Coleman, CFA SVP, Sr. Analyst (212) 338-4718

Restaurants Engineering and Construction


Lynne Collier Mng. Dir. (214) 702-4045 Chase Jacobson VP, Sr. Analyst (212) 338-4753
Philip May Analyst (214) 702-4004
Industrial Components
ENERGY Samuel H. Eisner VP, Analyst (212) 338-4705
Oilfield Services & Equipment
David S. Havens Mng. Dir. (212) 763-8238
Multi-Industry
Nicholas P. Heymann Mng. Dir. (212) 338-4703
FINANCIAL SERVICES Paul A. Dircks Analyst (212) 338-4725
Jordan Calabrese Associate (212) 338-4729
Asset Management
Jason Weyeneth, CFA SVP, Sr. Analyst (212) 763-8293 TECHNOLOGY
Banks & Thrifts LED Supply Chain
James M. Schutz Dir. of Fin. Ser. (864) 241-3384 Andrew Huang Mng. Dir. (415) 362-6143
Adam Barkstrom, CFA Mng. Dir. (800) 906-0577 Naghmeh Rabii Associate (415) 362-6141
Blair Brantley, CFA Analyst (800) 621-8635
Semiconductors
Matthew Kelley Mng. Dir. (207) 699-5800
Vijay Rakesh Mng. Dir. (312) 525-8431
Mike I. Shafir SVP, Sr. Analyst (212) 763-8239
Ryan Brookman Associate (312) 525-8430
Matthew Breese Analyst (207) 699-5800
Edward D. Timmons SVP, Sr. Analyst (800) 203-5332
Ashby W. Price Associate (888) 477-9602 TRANSPORTATION, SERVICES & EQUIPMENT
Brett Rabatin, CFA SVP, Sr. Analyst (877) 457-8625 Jeffrey A. Kauffman Mng. Dir. (212) 338-4765
Kenneth James Analyst (615) 760-1474 Sal Vitale VP, Analyst (212) 338-4766
Peyton Green Mng. Dir. (877) 492-2663 Kanchana Pinnapureddy Associate (212) 338-4767
Joe Maloney Analyst (615) 760-1468
ADMINISTRATION
Life Insurance Carlo Francisco Supervisory Analyst (914) 434-3451
John M. Nadel Mng. Dir. (212) 338-4717 Marianne Pence Mgr., Res. Admin. (205) 949-3618
Dennis Zavolock Analyst (212) 338-4748 Nathan Mitchell Editor (205) 949-3635
Elizabeth Koch Editor (615) 289-4122

Email Address for Sterne Agee Employees: first initial + last name@sterneagee.com (e.g., jsmith@sterneagee.com)

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