UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.DC 20549
FORM 10-K
[X]
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For Thethe Fiscal Year Ended June 28, 1998
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR
15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ____ to _____
Commission File No. 0-2115427, 1999
CREE RESEARCH, INC.
(Exact name of registrant as specified in its charter)
North Carolina 0-21154 56-1572719
(State or other jurisdiction of(Commission File No.) (I.R.S. Employer
incorporation or organization)jurisdiction Identification No.)Number)
of incorporation)
4600 Silicon Drive, Durham, NCNorth Carolina 27703
(Address of principal executive offices)
(Zip Code)
Registrant's(919) 313-5300
(Registrant's telephone number, including area code: (919) 361-5709code)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.005$0.0025 par value
-----------------------------
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No[No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X][ ]
The aggregate market value of common stock held by non-affiliates of the
registrant as of August 7, 19982, 1999 was approximately $149,174,000$794,388,471 (based on the
closing sale price of $14.125$29.375 per share).
The number of shares of the registrant's Common Stock, $0.005$0.0025 par value per
share, outstanding as of August 7, 19982, 1999 was 12,991,038.29,258,464.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the definitive Proxy Statement to be delivered to shareholders in
connection with the Annual Meeting of Shareholders to be held November 3, 19982, 1999
are incorporated by reference into Part III.
1
CREE RESEARCH, INC
FORM 10-K
For Thethe Fiscal Year Ended June 28, 199827, 1999
INDEX
Part I Page
Item 1. Business 3Business........................................................3
Item 2. Properties 15Properties.....................................................19
Item 3. Legal Proceedings 16Proceedings..............................................19
Item 4. Submission of Matters to a Vote of Security Holders 16Holders............19
Part II
Item 5 Market for Registrant's Common Equity and Related
Stockholder Matters 16Matters............................................19
Item 6. Selected Financial Data 16Data........................................20
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 18Operations............................21
Item 8. Financial Statements and Supplementary Data 24Data....................30
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosures 45Disclosures...........................50
Part III
Item 10. Directors and Executive Officers of the Registrant 46Registrant.............50
Item 11. Executive Compensation 46Compensation.........................................50
Item 12. Security Ownership of Certain Beneficial Owners and
Management 46Management.....................................................50
Item 13. Certain Relationships and Related Transactions 46Transactions.................50
Part IV
Item 14. Exhibits, Financial Statement Schedules and Reports
on Form 8-K 46
Signatures 49
28-K....................................................51
SIGNATURES ...............................................................53
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PART I
Item 1. Business
GeneralINTRODUCTION
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Cree Research, Inc. ("Cree" or "the Company"), a North Carolina corporation, was established in 1987 to
commercialize the production of silicon carbide, ("SiC") material and to develop and market SiC-basedor SiC, semiconductor wafers and devices. Today,
Cree is the world leader in developing and manufacturing semiconductor materials
and electronic devices made from SiC and other wide bandgap compound
semiconductor products. In December 1987,Using its proprietary compound semiconductor technology,
the Company acquired an exclusive license to certain technology, developed at North
Carolina State University ("NCSU") relating to silicon carbide, including a
process for bulk growth of single crystalline SiC. The Company has refined and
improved this technology over the past eleven years and is now a world leader in
the design, development, manufacture and marketing of SiC-based semiconductor
materials and electronic devices. The Company incorporates its proprietary
silicon carbide technology to produce compound semiconductorsproduces light emitting diodes, or LEDs, for use in back-lighting,automotive and
liquid crystal display, or LCD, backlighting, indicator lamps, full color LED
displays and other lighting applications. The Company also manufactures SiC
crystals that are sold for useused in the production of unique gemstone products and SiC wafers that are sold
for research directed to optoelectronic,optoelectronics, microwave and power devices. The Company believes that,applications. Cree
has recently introduced the first of a family of radio frequency, or RF, and
microwave devices for certain electronic
applications,use in wireless base stations, radar systems and other
commercial and military applications. These products are expected to be
available on a sample basis during fiscal 2000. SiC-based compound semiconductor
devices offer significant advantages over competing products based on sapphire, silicon,
gallium arsenide, or GaAs, and other materials.
The original application of the Company's SiC technology was the
world's first commercially viable blue light-emitting diode ("LED").materials for certain electronic
applications. The Company markets itshas new product initiatives based on SiC, including
additional RF and microwave devices, larger and clearer crystals for moissanite
gemstones, blue laser diodes for optical storage applications and power devices
for power conversion or switching uses.
BACKGROUND
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Most semiconductor devices are fabricated on wafers made from silicon crystals.
Silicon evolved as the dominant semiconductor material because it is relatively
easy to grow into large, single crystals and is suitable for fabricating
numerous electronic devices. Alternative materials, such as GaAs, have emerged
to enable the fabrication of new devices with characteristics that could not be
obtained using silicon, including certain RF, microwave, LED, chip products principally to customers who incorporate them
into packaged lampslaser and other
optoelectronic devices. However, GaAs, silicon and other widely used
semiconductor materials have certain physical and electronic characteristics
that limit their usefulness in many applications. For example, silicon and
GaAs-based semiconductors are not suitable for usethe fabrication of short
wavelength optoelectronic devices. In addition, the power handling capabilities
of silicon and GaAs-based microwave transistors can limit the power and
performance of microwave systems used in many commercial and military aerospace
applications. Furthermore, few silicon or GaAs devices can operate effectively
at temperatures above 400 degrees F. This is a major limitation in applications
such as indicator lightsadvanced electronic systems for high power electric motors, jet engines
and in back-lighting
applications, including automotive dashboard instrumentation, cellular handset
products and liquid crystal displays ("LCD"). The LED product is also
incorporated in full color display products used for advertising and in sports
arena video replay boards.
The Company also believes that it supplies much of the worldwide demand
for SiC wafer products to corporate, government, and university laboratories.
These customers utilize the material in thesatellites.
Substantial research and development efforts have been undertaken to explore the
properties of optoelectronicother potential semiconductor materials. These efforts have
identified few candidate materials that are capable of being grown as low defect
single crystals (a requirement in the production of most semiconductors) which
also possess physical and electronic properties that meaningfully increase
device performance over products fabricated from semiconductor materials in
general use. Of the few potential candidates, the properties of SiC make it an
excellent material for extending existing semiconductor device technology where
high power, high temperature or short wavelengths are important for performance.
-3-
SiC OVERVIEW
- ------------
SiC has many physical characteristics that make the material very difficult to
produce. For example, in a typical semiconductor manufacturing process, the
semiconductor material is grown in single crystal form and sliced into wafers.
The wafers are then polished and chemically etched, coated with a thin film
containing controlled levels of impurities and fabricated into devices. Because
SiC can form many different atomic arrangements and must be grown at process
temperatures above 3,500 degrees F, it is difficult to grow large single
crystals that are homogeneous in structure. In addition, the high temperatures
required to grow SiC make the control of impurity levels in SiC crystals and
thin films difficult. "Micropipes," or small diameter holes, may appear in the
crystals during crystal growth, affecting the electrical integrity of the wafer
and reducing the usability of portions of the wafer for certain applications.
Furthermore, slicing and polishing SiC wafers is hindered by the intrinsic
hardness of the material. Similarly, its inherent chemical resistance makes SiC
a difficult material to etch.
Many of the same physical characteristics that make SiC difficult to produce
also make it an excellent material for certain semiconductor applications. The
following characteristics distinguish SiC from conventional silicon and
GaAs-based semiconductor materials, resulting in significant advantages for many
applications in which the production hurdles can be overcome:
WIDE ENERGY BANDGAP. Bandgap is the amount of energy required to move an
electron from the valence band to the conduction band. SiC is classified as a
"wide bandgap" semiconductor material, meaning that more energy is required for
ionization. Electronic devices includingmade from this material can operate more
efficiently and at much higher temperatures than devices made from other common
semiconductor materials.
HIGH BREAKDOWN ELECTRIC FIELD. The "breakdown electric field" is the amount of
voltage per unit distance that a material can withstand and still effectively
operate as a semiconductor device. SiC has a much higher breakdown electric
field than silicon or GaAs. This characteristic allows SiC devices to operate at
much higher voltage levels. Additionally, it allows SiC power devices to be
significantly smaller while carrying the same as or greater power levels than
comparable silicon and GaAs-based devices.
HIGH THERMAL CONDUCTIVITY. SiC is an excellent thermal conductor compared to
other commercially available semiconductor materials. This feature enables
SiC-based devices to operate at high power levels and still dissipate the excess
heat generated.
HIGH SATURATED ELECTRON DRIFT VELOCITY. SiC has a "saturated electron drift
velocity" higher than that of silicon or GaAs. The saturated electron drift
velocity is the maximum speed at which electrons can travel through a material.
This characteristic, combined with a high breakdown electric field, allows the
fabrication of SiC-based microwave transistors that operate at significantly
higher power levels than current silicon and GaAs-based devices.
ROBUST MATERIAL. SiC has an extremely high melting point and is one of the
hardest known materials in the world. SiC is also extremely resistant to
chemical breakdown and can operate in hostile environments. As a result, SiC can
withstand much higher electrical pulses and is much more radiation-resistant
than silicon or GaAs.
-4-
GEMOLOGICAL APPEAL. In the gemstone industry, SiC is known as moissanite. Its
high refractive index and dispersion give it "diamond-like" sparkle or fire. In
addition, its hardness allows superior faceting and wear resistance compared to
many gemstone materials.
THE CREE SOLUTION
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Through its proprietary technology and over 10 years of development and
manufacturing experience, Cree has succeeded in overcoming difficulties in
processing SiC for commercial use. The Company introduced its first product in
October 1989 and currently is the leading manufacturer of SiC wafers and
SiC-based blue and green LED products in the world. The Company believes that
its proprietary process techniques and the inherent attributes of SiC give Cree
significant advantages over competing products for certain electronic and
gemological applications. These advantages include:
BLUE AND GREEN LIGHT EMISSION. Cree produces high efficiency blue and green LEDs
using gallium nitride, or GaN, a wide bandgap material, and other nitrides grown
on SiC substrates. Most other manufacturers of nitride-based LEDs use sapphire
substrates. The conductive properties of SiC enable Cree to fabricate a simpler,
smaller LED chip as compared to competing LEDs grown on sapphire substrates.
Cree has also demonstrated and is continuing development of GaN-based blue laser
diodes grown on SiC. The principal advantages of SiC over other substrate
materials for blue laser diodes are its high electrical and thermal conductivity
and its ability to be cleaved, providing an excellent surface for laser light
emission.
ENABLING SUBSTRATE PROPERTIES. The inherent attributes of SiC as a substrate
enable researchers to work on developing new optoelectronic, microwave and power
devices that offer significant advantages over competing products and which
could not be produced as effectively on other substrate materials. The Company
manufactures SiC wafers for both internal use and sale to external development
programs to further new product development. The Company continues to develop
larger substrates with lower defect densities, which should drive further device
development and strengthen SiC's economic advantages in certain applications.
GEMSTONE MATERIAL PROPERTIES. Cree manufactures SiC crystals that are used to
produce moissanite gemstones. The combination of SiC's optical properties (high
refractive index and dispersion) and robust material properties give these
gemstones both diamond-like sparkle or fire and hardness characteristics. Cree
continues to develop larger and higher quality SiC crystals for this
application.
HIGH POWER RF AND MICROWAVE OPERATIONS. The Company has demonstrated SiC RF and
microwave transistors that can operate at much higher voltages than silicon or
GaAs because of SiC's high breakdown electric field, allowing much higher power
operation at high frequencies. Higher power SiC devices can allow the
fabrication of SiC-based RF transmitters with less circuit complexity and higher
total output power. These same advantages exist for microwave devices made using
GaN on SiC substrates, which can also operate at much higher frequencies than
SiC-only devices. In the fourth quarter of fiscal 1999, the Company introduced
its first RF power transistor product, a SiC metal semiconductor field effect
transistor or MESFET device, which is the first in a planned family of RF power
transistor products designed for wireless and broadcast applications. The
Company is continuing development of additional RF and microwave devices for use
in wireless transmissionbase stations, radar systems and digital ultra high frequency ("UHF") broadcastother commercial and
highdefense-related applications.
-5-
HIGH POWER, HIGH VOLTAGE OPERATION. Cree is developing SiC power diodes and
switches that are able to operate at higher power densities than currently used
semiconductor materials because of the much higher breakdown electric field of
SiC. In addition, Cree believes that its SiC power devices will be able to
operate with lower resistive losses and lower switching losses than those made
with silicon or GaAs.
PRODUCTS
- --------
All of Cree's products are an outgrowth of its SiC technology. The following
chart illustrates the Company's existing products and user applications for
which these products are being used or marketed:
PRODUCT USER APPLICATIONS
Blue and green LEDs o Backlighting such as automotive
dashboards and LCDs, including power rectifiers and switches, as well as other
applications.
One customer, C3, Inc. ("C3") uses SiC as a gemstone material. The
product is sold in bulk crystal form and then cut, faceted and polished by C3 to
create gemstones with diamond-like characteristics. Physical properties of SiC
are similar to those of diamond as they are both carbon-based minerals with a
similar hardness.
In August 1994, the Company formed a wholly-owned subsidiary, Real
Color Displays, ("RCD"), to develop and marketwireless
handsets
o Large indoor full color LED moving message
displays. As an entry into this business, RCD acquired the assets of a Hong-Kong
based company engaged in the sale of moving message signs. Vertical integration
into the LED display market was seendisplays, such as
a means for the Company to enhance its
core position in LED chip production. RCD's strategy was to target the low-endarena video screens
o Large outdoor full color moving message display market, which is comprised of onedisplays
o White light products to replace miniature
incandescent bulbs, such as those used in
automobile map lights
o Traffic signals
SiC wafers and two-line
message signs that display text messagescrystals o Research and single graphics, however, these
products have been de-emphasized in recent years. During the second half of
fiscal 1996, Cree introduced adevelopment for new
LED based product, marketed as the "Real
Color Module TM" component, which the Company sells to original equipment
manufacturers ("OEMs") for use in building large area video display systems.
This product has become the primary focus for the future of the Company's
display business.
3
The Company performs research directed to developing future products
usingsemiconductor applications (wafers)
o Gemstones (crystals)
SiC RF transistors and believes that it leads an advanced study of these devices
worldwide. This research focuses on optoelectronic, microwaveo Communication systems and other power
devices.
A substantial amount of Cree's internal research projects are funded by Federal
government agencies and departments.wireless base station applications
amplifiers
The Company's products are manufactured in a manner similarsix-part process which includes:
SiC crystal growth, wafer slicing, polishing, epitaxial deposition, fabrication
and testing. SiC crystals are grown using a proprietary high temperature process
designed to produce uniform crystals in a single crystalline form. Crystals used
for moissanite gemstones exit the manufacturing process at this stage. Crystals
used for other semiconductor materials and devices. Silicon carbide is combined with other
materials and then fabricated into single crystals. The crystalsproducts are then sliced into wafers. The wafers andare polished and
either sold as bare wafer material, orthen processed for further manufacture. Veryusing the Company's proprietary epitaxial deposition technology,
which essentially consists of growing thin layers of additionalSiC, GaN or other material may be grown
on the barepolished wafer, using adepending on the nature of the device under production.
SiC wafer products may leave the manufacturing process referred to as epitaxial deposition. Wafers with
these epitaxial layers may be sold outrighteither after polishing or
used to manufacture other
devices. Wafers that continue for device manufactureepitaxy. Following epitaxy, LED and microwave chips are then fabricated in a clean
room environment through various processing steps.environment. The devices fabricatedfinal steps include testing and packaging for shipment to
the customer. In manufacturing its products the Company depends substantially on
its custom-manufactured equipment and systems, some of which is manufactured
internally and some of which the waferCompany acquires from third parties and
customizes itself.
BLUE AND GREEN LEDs
LEDs are then testedsolid-state chips used in miniature lamps in everyday applications such
as indicator lights on printers, computers and cut into chips for sale as LEDother equipment. LEDs generally
offer substantial advantages over small incandescent bulbs, including longer
life, lower maintenance cost and energy consumption, and smaller space
requirements. Groups of LEDs can make up single or other
products.
Descriptionmulticolor electronic
displays. Prior to the introduction of Business Products
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Blue LEDs
Cree introduced the world's first commercially viableCree's blue LED chip product in 1989, andblue
LEDs could not be produced in volumes necessary
-6-
for commercialization. Since then, Cree has since developed several generations of
blue LED products, including a more robust conductive buffer chip introduced in fiscal
1998 that is brighter, easier
to manufacturebuild into lamps and has a lower unit cost. Prior to
1989, a blue LED was not readily available as the semiconductor materials used
in red, amber and yellow-green LEDs, are not able to emit blue light. Blue LEDs
offered by others at this time were laboratory samples that could not be
produced in volumes necessary for commercialization. Inexpensive red, amber and
yellow-green LED lamps have been available for moreprice than 20 years and are
used in everyday applications such as indicator lights on printers, computers
and other equipment, and traffic signal lighting for red devices. Groups of
these lights are also used for single or multicolor electronic displays.competing products. The
commercial availability of the blue LED, in conjunctiontogether with red and green, is
critical to enablehas
enabled the creationdevelopment of multiple chipfull color LED lamps and displays capable of
producing any color in the visible spectrum. Combinations of blue, green and red
light in a single cell can create any color light, including white light, making
it possible to create large video displays using LED technology. In addition,
blue LEDs can be used as indicator lamps, in back-lighting and in various other
applications in which red, amber and yellow-green LEDs are used today. LEDs
offer substantial advantages over the small incandescent bulb, including longer
life, lower maintenance and energy consumption and smaller space requirements.displays.
The Company believes that its approach of manufacturingLEDs made from SiC substrates provide the following
benefits over those made with competing substrates: 1) an industry standard
vertical chip structure requiring a bluesingle wire bond that results in faster LED
based onassembly and reduced cost, 2) a two inch diameter SiC substrate offers a more cost effective design
and process than its competitors, who use a sapphire substrate. The Cree
approach is compact and uses the same top and bottom contact arrangement that is
employed in standard red, amber and yellow-green LED products. Most competitors
place both the positive and negative contact on the top of the diode because the
sapphire substrate material used in their products is not electrically
conductive. Cree's smaller chip design enablessize compatible with industry
trends toward package miniaturization, 3) the diode to use less material
and permits more devices to be fabricated on each wafer processed. Competitors
offer the blue LED at selling prices higher than the Company's prices. The
Company has been working continuously to reduceindustry's highest specification
for electrostatic discharge resistance that reduces the cost, of its blue LED chip as
it believes the rate of market acceptance for blue LED products is significantly
dependent on pricing. The Company also anticipates the market for single blue
LED lamps will increase significantly once the pricing of these products is
similarengineering effort
and time to that of the red, amberqualify LEDs at customer production sites and yellow-green LED products available today.
During fiscal 1998, the Company was able to reduce its cost to manufacture an
improved blue LED product by more than 50% through higher throughput, improved
yields, smaller die size, larger wafer size and other attributes of the
conductive buffer process. If the Company can continue this trend, it
4
will allow greater flexibility in pricing to customers in the future. There is
no assurance, however, that the Company will be able to achieve4) a lower costs in
the future or that lower costs will produce increased sales.priced
outdoor capable product.
Presently, the Company's blue LED chips are primarily used for back-lightingbacklighting purposes, insuch as
automotive dashboard, cellular handsets,dashboards and LCD displays, and other applications.including wireless handsets. In
addition, they are also used in office equipment indicator lighting, indoor full-colorfull color video
display technology, such as stadiumarena video replay boards, moving message
advertising and informational signs. The Company's standard blue LED products
are primarily used in indoor applications. In September 1998, the Company first
began shipping brighter blue and green LEDs that offer a lower cost, higher
efficiency LED solution for existing applications that require a higher
brightness. These products, which were introduced generally in May 1999, are
used for backlighting purposes, where low power consumption is critical, such as
LCD displays for wireless handset applications, and for traffic signals and
outdoor full color displays.
In November 1998, Cree announced a new product line built on its blue LED
products for use in solid-state white light applications. By passing blue or
near ultraviolet LED output through certain conversion materials such as
phosphors or polymers, blue light is converted into white light. Cree currently
sells blue LEDs to a customer who produces the white light conversion LED.
Commercial products incorporating Cree's chips for white light conversion are
backlighting applications for automobile dashboards and instrumentation and LCD
backlighting for wireless handsets. Other applications for white light LEDs
include miniature incandescent lighting, such as map lights, automobile trunk
lights and small flashlights.
The Company supplies blue and green LED chips to LED component manufacturers who
assemble the chip into a lamp and then manufacture solid-state lighting
components to supply to OEMs. The majorityLED products represented 51%, 48% and 53% of the market for LED-based display
applications is in the Pacific Rim. The Company's principal customers who serve
the display market are located in China, Taiwan and Japan. Cree also sells the
LED product to European and domestic accounts.
Wafer Products
The Company believes that it is the leading manufacturer of
semiconductor quality silicon carbide in the world today. Cree grows its own
crystals using a proprietary process. The crystals are sliced into wafers,
polished and then preparedour
revenue for the Company's own manufacturing line orfiscal years ended June 27, 1999, June 28, 1998 and June 30,
1997, respectively.
MATERIALS PRODUCTS
Cree manufactures SiC wafers for sale to corporate, government and university
programs that are usinguse SiC for the
development ofdeveloping electronic components. SiC wafers are
distributed directly to these parties. These customers utilize the material as
the basis for research in optoelectronic, microwave and high power devices. Each
order may be sold as a bare wafer or customized by adding epitaxial films,
depending upon the nature of the customer's development program. These customers utilize the material as the basis for
research in optoelectronic, microwave and high power devices. For the past
several years, the Company has worked to improve the quality of its wafers while
increasing thetheir size. The absence of crystal defects is critical to the
development of high power devices in SiC. During fiscal 1998,1999, the Company has
been able to reduce these defects by approximately 50%.achieved significant
improvement in wafer quality for its two-inch sized wafers. Cree is currently
developing two
inch diameter wafers and expects that these wafers will constitute the majority
of material sales during fiscal 1999, although development delays could defer
such sales. This largera three-inch sized wafer will replace the 1 3/8 inch productproduct.
Single crystalline SiC has characteristics that are similar to diamond,
including properties relating to hardness and brilliance. Through a proprietary
process, Cree manufactures SiC crystals in near colorless
-7-
form for use in gemstones. The Company sells SiC crystals directly to C3 Inc.
("C3"), a company which
comprised the majority of sales in 1998. The larger diameter wafer is expected
to enable lower wafer costs per chip for customers by substantially increasing
the total amount of chips per wafer. The potential market for wafers depends on
whether the Company's customers are successful in creating commercial products
using SiC materials.
Silicon Carbide Crystals for Gemstone Applications
During fiscal 1998, the Company worked under development agreements
with C3. C3 was founded to develop gemstone products from SiC
crystals. These
agreements, which were amended and restated in July 1998 as a single agreement,
call for the development of improved processes for the manufacture of near
colorless, large volume silicon carbide crystals for use in lab created gemstone
products. While the focus of this agreement is currently to increase crystal
size and volume, longer term goals include the development of crystals with a
higher color range. The development agreement will enable the Company to perform
further research in the creation of larger volume SiC crystals that may
eventually be employed in other products.
The Company also provides SiC crystals to C3 pursuant to an exclusive
supply agreement. C3 cuts and polishes the product to fabricate diamond-like gemstones. Recently,gemstones
targeted at customers who desire affordable high quality jewelry. During the
first half of fiscal 1999, Cree significantly expanded crystal growth capacity
for C3 has ordered additional crystal grower equipment from
Cree and contracted to increasemeet increased volume requirements. Cree has recently agreed to an
additional capacity expansion that is planned through the first half of fiscal
2000. The potential for increasing demand depends on Cree's ability to meet C3's
requirements for color, clarity and yield. Consequently, Cree has agreed to
focus development efforts on improving its manufacturing processes to increase
crystal size and volume, as well as to develop crystals with higher quality.
Future demand also is also dependent on C3's ability to cut, facet and effectively
market its gemstone products. ModulesSiC produced for gemstone applications is
distributed directly to C3. Wafer and Moving Message Signs
5
other material products represented 38%,
34% and 24% of our revenue for the fiscal years ended June 27, 1999, June 28,
1998 and June 30, 1997, respectively.
MICROWAVE TRANSISTORS
In June 1999, Cree announced the first of a family of SiC-based RF and microwave
transistor products designed to be a part of the power amplification process. A
second phase of transistor products is scheduled for release to production in
fiscal 2000. The Company markets a modular LED-based componentexpects that these products will be sold to customers as a
building block for indoor video and display systems. The product is a low
profile full-color LED sub-assembly for use in both large and small scale
full-color LED display systems. It uses surface mount pixels which combine the
three primary color LED chips which are assembled into very thin modules. The
modules can be combined to form any size display.
Due to the diverse market for LED display systems, the Company cannot
effectively address all opportunities at the display system level and has
therefore chosen a strategy of supplying modules directly to well established
LED display system suppliers. This approach maximizes the efficiency of the
Company's sales resources, minimizes the capital investments that would need to
be made as a systems supplier, and does not place the Company in competition
with potential display system customers.
The Company's RCD subsidiary has been manufacturing full color moving
message sign products since its inception in August 1994. The Company is able to
produce a variety
of color moving message products. The signamplifier producers, including wireless base stations and digital broadcast
applications. While distribution of samples will commence in early fiscal 2000,
the Company believes that these products rangewill be sold in brightness from indoor to high-bright, which is suitable for store window
applications. These products provide a low cost and effective way of displaying
text messages which can be easily changed and updated. The applications for
these displays include point-of-sale advertising and informational signs.
The Company is currently reviewing the business plans for both of these
product lines to maximize sales for fiscal 1999. The Company is developing a
brighter blue and pure green LED product which is expected to be introducedlimited quantities
during fiscal 1999, although development delays could defer the product
introduction. The new LEDs are expected to provide the display business a low
cost, high performance product suitable for outdoor applications. This
expected upgrade in technology is anticipated to change market opportunities for
these products.
Product Development
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The Company is engaged in a number of research and development
projects. Some projects have the goal of developing commercial products2000, as design cycles for the market in the near term. Other projects have longer term goals. There can be no
assurance as to the successful development of commercial products or the timing
thereof. All of the products under development are based on SiC materials grown
using the Company's proprietary processes.
The Company partners with the Federal government in many of its current
research and development efforts. Contracts are awarded to the Company to fund
both short-term and long-term research projects. Funding for projects with near-
term applications for the Company typically include a cost-share arrangement.
Projects that may not have readily available production applications or projects
that relate to longer term development are normally awarded on a cost-plus basis
with built-in margins exceeding 5%. Pursuant to each contract, the amount of
funding is determined based on cost estimates that include direct costs, plus an
allocation for research and development, general and administrative costs, and a
cost of capital expense. Cost-plus funding is determined based on actual costs
plus a set percentage margin. For cost-share contracts, the actual costs are
divided between the U.S. Government and the Company based on the terms of the
contract. The government's cost-share is then funded to the Company. The
contracts typically require the submission of a written report to document the
results of such research. The government may terminate contracts with the
Company at its convenience and typically obtains a nonexclusive license to use
any inventions made in the course of the research solely for government
purposes.
6
For financial reporting purposes, the Company includes funding for all
cost-plus and cost-share contracts, where the Company anticipates that total
funding will exceed direct costs over the life of the contract, as contract
revenue. All associated direct costs for these contracts are reported as a cost
of contract revenue. For cost-share contracts where the Company anticipates that
costs will exceed funding over the life of the contract, funding is reflected as
a reduction of research and development expenses, while the associated direct
costs are reported as research and development expenses. During fiscal years
1998, 1997 and 1996, the Company spent $8,474,000, $9,411,000, and $5,572,000,
respectively, for direct expenditures relating to product research and
development activities. During the same periods, the U.S Government funded
$8,241,000, $8,760,000 and $5,721,000, respectively, for direct and indirect
expenses. In addition, customers have also sponsored research activities
relating to the development of new products. During fiscal years 1998 and 1997,
customers spent $3,477,000 and $66,000, respectively, for product research and
development activities. In fiscal 1996, customers did not provide significant
funding for research activities. The Company expects to continue to perform
substantial research and product development projects during the next fiscal
year.
The followingtarget applications are currently under research and development
by the Company. The Company expectsgenerally
several of these applications to be
completed in fiscal 1999, although delays could occur. Other development
projects, such as power devices and blue laser research are not expected to
produce commercial results until later years.
Silicon Carbide Material
The Company continually conducts research aimed at improving the
quality of its wafers and enhancing its epitaxial (active layer) process. The
Company believes it can increase the diameter of its wafers while lowering
manufacturing costs and permitting the development of more complex devices. The
key determinant that will enable the manufacture of a more complex device, such
as power semiconductors, is the substrate quality and wafer size. Epitaxial
thickness, lower defect density and the elimination of variation are important
factors to improve yield, marketability and lower cost. The larger two inch
wafer size, which the Company expects will comprise the majority of fiscal 1999
wafer sales, is considered a minimum standard for many niche fabrication
facilities. The Company continues work on a $7.6 million contract awarded by the
Defense Advanced Research Projects Agency ("DARPA") to fund this research and
development. The contract has $1,702,000 in funds remaining and extends through
May 1999.
Lower Cost Blue LED Chips
In fiscal 1998, Cree developed a blue LED that was brighter than its
prior generation blue LED. The brighter chip was developed by using a new
process that allows a chip design in which current flows vertically through the
device. This design, which is currently manufactured on a two inch wafer, yields
more chips per wafer and requires fewer manufacturing steps; therefore, it is
produced at a lower cost.
In order for the product to approach the acceptance and marketability
of red, amber and yellow-green LEDs, the Company's management believes the price
of the chip must be further reduced. In order to reduce the cost of production,
the Company must attain success in increasing volume throughput by expanding the
customer base, and develop additional manufacturing yield improvements. These
modifications are expected to significantly reduce unit costs by improving the
die per wafer yield and spreading fixed costs over more units.months. There can be no assurance that these goalssuch producers or other customers
will be achieved. If the Company does not achieve
sufficient increases in yields and volume throughput, then costs would fail to
decline significantly and the Company's ability to generate higher margins or to
maintain margins while reducing chip prices would be impaired.
Brighter Blue and Green LED Chips
7
The Company is workingable to develop brighter blue and green LEDsapplications in the near future that would be cost-effective for outdoor applications. This design employs
indium gallium nitride layers on silicon carbide. The current generationwill require
commercial production of the Company's blue LEDRF products are primarily usedor that such products will be
successful in indoor applications, as the brightness of the product is not as high as some competing products.market.
PRODUCTS UNDER DEVELOPMENT
- --------------------------
The Company believes that this chip will openthe inherent physical characteristics of SiC make it
an excellent material for many new markets with a low cost platform. Creesemiconductor applications. The Company is
also developing twodedicated to creating new green LEDapplications using SiC and has products that employcurrently
under development in each of the same technologyareas described below. The following chart
illustrates the potential user applications for each area of product
development:
PRODUCT CATEGORY POTENTIAL USER APPLICATIONS
High power RF and o Amplifier systems for wireless applications,
microwave devices such as the new brighter blue offering. These products are expected to be suitable for
the outdoor LED display marketpersonal communication systems, or
PCS base stations and for traffic signaldigital broadcast
o Radar systems
Power devices o Industrial motor controls
o Electric vehicles
o Lighting ballasts
o Factory robotics
o Locomotive applications
respectively. Samples of these new products are expected to be released in the
first quarter of fiscal 1999, although introduction could be delayed by
unforeseen development problems.
High-Power Radio Frequencyo Solid-state power transmission
Blue and Microwave Transistorsultraviolet o High density optical storage, such as CDs and
lasers DVDs
High temperature devices o Automotive and aerospace electronics
-8-
HIGH POWER RF AND MICROWAVE DEVICES
The Company is currently developing high-powerSiC-based high power transistors that
operate at radio and microwave frequencies. SuchThe Company believes these devices
couldwill have important applications in cellularwireless phone base stations, high-powerhigh power solid-state
broadcast systems for television and radio and radar search and detection
equipment.
The Company also continues developmentIn June 1999, Cree introduced the first of a family of RF and microwave
transistor products. As discussed above, the Company continues to develop other
SiC-based device which istransistor devices that are expected for prototype distribution during
fiscal 2000. All of these products are designed for useto amplify power in base stations for wireless systems. This device, which is
notseveral
applications. These devices are expected to be released commercially before late fiscal 1999, can be used for frequency band
applications above 1.8from 400 megahertz to 2.5 gigahertz, such as the personal
communications system ("PCS")including PCS base station
network currently being installed by
some wireless carriers.networks. The Company believes that silicon carbideSiC transistors will be superior tooffer advantages over
current silicon and gallium arsenideGaAs-based devices for certain applications due to greater
output power per transistor. The higher output power available from SiC devices
is expected to allow wireless systems to use fewer transistors per base station
andresulting in less complex circuitry at aand lower cost.
ThisCree is also developing GaN-based microwave transistors on SiC substrates that
are targeted for higher frequency applications (10 to 30 gigahertz). During
fiscal 1999, the Company reported the demonstration of GaN on SiC transistors
that operated with an output power of 9.0 watts at 7.4 gigahertz. The Company
also reported a record high power density of 6.9 watts per millimeter at 10
gigahertz on smaller GaN devices. The Company believes this power density is four to five
timesthe
highest publicly reported for a solid-state field-effect transistor operating in
this frequency range and is substantially higher than that achieved with
equivalent silicon or gallium arsenideGaAs-based devices. In addition, SiC's ability to dissipate heat more rapidly than other
materials reduces the need for costly cooling equipment. In March 1998, theThe Company demonstrateddoes not anticipate that a device with 53 watts of power from a single chip. Cree
expects to offer a product that emits 75-100 watts of power from a single chip
in order to reach commercial viability. During fiscal 1998, the Company
continued to work on several contracts from Naval Research Laboratories, DARPA,
and the Army Research Laboratories to advance this research. These contracts
extend through August 1999.
During fiscal 1998, the Company reported the demonstration of gallium
nitride on SiC transistors that, although low in total output power, operate at
a power density of 6.8 watts per millimeter at 10 gigahertz. This power density
is the highest ever reported for a solid state field effect transistor operating
at radio or microwave frequency and is eight times higher than that achieved
with equivalent silicon or gallium arsenide devices. A
commercial device capable of emitting power at this level will be available in
the near term.
POWER DEVICES
The Company is notdeveloping prototype high power devices that have many potential
uses. Such devices could be employed in applications involving power
conditioning as well as power switching. SiC-based power devices have the
potential to handle significantly higher power densities than existing
silicon-based devices. In addition, SiC devices are expected duringto operate at
significantly higher temperatures and voltages with superior switching
capabilities. These devices are expected to yield substantial power savings due
to reductions in energy losses made possible by the nextdevices' high efficiency.
Potential applications include power drive components for electric vehicles,
lighting ballast components, industrial motor controls and power conditioning
for high voltage power transmission. In early fiscal year.
Blue1999, the Company entered
into a three-year project with Kansai Electric Power Company, one of the largest
power companies in the world, for development of SiC-based devices for use in
power transmission networks.
BLUE AND ULTRAVIOLET LASER DIODES
The Company continues to focus on the development of blue and Ultraviolet ("UV") Laser Diodesultraviolet laser
diodes. SiC's inherent attributes, including its natural cleavability and high
thermal conductivity, make it an excellent material for blue laser applications.
The storage capacity of optical disk drives can be increased significantly by
utilizing a laser diode capable of emitting short wavelength light. The Company
has demonstrated a blue laser diode, fabricated from indium gallium
nitrideGaN and related materials
deposited on SiC substrates, that emitswhich has a shorter wavelength blue light than that of the red or
infrared lasers used today. This
technologyThe Company believes that the shorter wavelength of
blue light could potentially increase theresult in storage capability ofcapacity for optical disk drives
that is significantly greater
-9-
than the capacity permitted by a factor of four to five.red light. This increased storage capabilitycapacity could
lead to advances in CD-ROM data storage and audio and video compact disc
applications. Government funds were last allocatedCurrently, the Company is the only U.S.-based firm to developmenthave
demonstrated the continuous wave operation of thea blue laser diode in June of 1996 when DARPA awarded a $4.3 million contract to the Company
to be spent over a three year period. Most of these funds have now been
exhausted. As a part of this development, in July 1997 the Company announced
that it
8
had demonstrated a continuous wave laser operation at room
temperature.
Substantial worktemperature on SiC; however, there is still substantial work needed to produce a
blue laser suitable for commercial application. There can be no assurance that a commercial product will result
from this research and development effort.
High-Power Semiconductors
The Company is working on the development of prototype high power
devices that, if successfully developed, could have many significant uses. Such
devices could be employed in applications involving power conditioning as well
as switching power to allow electricity to flow to other electronic components.
SiC based power devices have the potential to handle up to fifty times more
power density than current silicon based devices. SiC devices are expected to
operate at significantly higher temperatures and voltages, have superior
switching capabilities, yet retain a die size almost twenty times smaller than a
silicon based device. Potential applications include power drive components for
electric vehicles, lighting ballast components, industrial motor controls, and
power supplies with minimal interruption used in power transmission. These power
devices are not anticipated to be commercially available during the nextapplications. During fiscal year.
The Company recently1999, Cree
entered into a three year, up to $3one-year development agreement with Microvision, Inc. ("MVIS").
This agreement provides $2.6 million project with Kansai Power Electric Company, the fourth largest power company in
the world,of funding for research in switching systems inedge-emitting
LEDs and laser diodes. At MVIS' option, this agreement may be extended for an
additional year for $2.5 million.
HIGH TEMPERATURE DEVICES
In certain applications for microwave and power transmission networks. The
Company continuesdevices, the ability of SiC to make progress in improving the quality of its SiC material,
improving processes for fabricating devices and improving device designs.
However, there is no assurance that further work will result in improvements in
processes, material quality and end products that are necessary to introduce
such products to market. Also, it is anticipated that the Company will need to
develop methods to reliably produce wafers of a three inch or greater diameter
in order to make such devices economically viable. There can be no assurance
that this will be accomplished. The Company continues to work under contracts
with the government and other sources for research in this area. Work is
currently being performed for the Office of Naval Research and other sources.
These contracts extend through September 2000.
Gemstone Applications
During fiscal 1998, the Company worked under development agreements
with C3. These agreements, which were amended and restated in July 1998 as a
single agreement, call for the development of improved processes for the
manufacture of colorless, large volume silicon carbide crystals for use in lab
created gemstone products. The agreement obligates C3 to pay Cree's direct costs
of the development effort, plus an overhead charge on certain costs. Work to be
performed under this contract during the next year will target the development
of larger sized crystals and is expected to result in a three inch diameter
crystal for possible use in other product applications.
High-Temperature Devices
The Company has developed prototype SiC-based transistors and
rectifiers that
operate at higher temperatures than comparable silicon devices can be a major
advantage. Thus, Cree is currently developing high temperature versions of these
devices. These high-temperature semiconductors havedevices would be used for applications in high temperature
environments or environments with limited cooling or heat sinking, including
potential applications in the automotive, energy and aerospace industries. For example, these devicesCree
is also working on high temperature sensors, as well as analog and digital
circuits that could be used to amplify low level sensor signals directly on thein a
jet engine block of an
automobile engine to measure engine performance. This allows the optimization of
fuel economy by adjusting engine performance during operation. In addition,
theseor other high ambient temperature environment. Such devices could
also find use in applications such as down hole drilling equipment and space-based power systems.equipment. Although
Cree has developed prototype devices, have been
developed, additional development work is needed to
achieve commercial viability.
WorkGOVERNMENT CONTRACT FUNDING
- ---------------------------
Cree derives a portion of its revenue from funding from research contracts with
the U.S. government. For the fiscal years ended June 27, 1999, June 28, 1998 and
June 30, 1997, government funding represented 11%, 18% and 23% of total revenue,
respectively. These contracts typically cover work performed over several months
up to three years. While the U.S. government is currently being performedinterested in Cree's development
of SiC materials and SiC-based devices, there can be no assurance that the
Company will enter into any additional government contracts, or that they will
be profitable or produce contract revenue. In addition, there can be no
assurance that after any such contracts are entered into, changing government
regulations will not significantly alter the benefits of such contracts. These
contracts may be modified or terminated at the convenience of the government.
The contracts generally provide that Cree may elect to obtain title to
inventions made in the course of research, with the government retaining a
nonexclusive license to practice such inventions for the Defense Special Weapons
Agency and other sources.government purposes.
RESEARCH AND DEVELOPMENT
- --------------------------------------------------------------------------------
9
Strategic Alliances
- --------------------------------------------------------------------------------------------------------
The Company believes that its ability to maintain its position as a leading
supplier of SiC material and SiC-based semiconductor products, will depend on
its ability to enhance existing products and to continue developing new products
incorporating the formation of strategic alliances with
other companieslatest improvements in SiC technology. Accordingly, the
Company is a viable strategy forcommitted to investing significant resources in research and
development.
The Company continually conducts research aimed at improving the immediate developmentquality of its
technology to bring certain products to market.crystals and wafers and enhancing its epitaxial film deposition (wafer coating)
process. Cree believes that these research and Siemens A.G. ("Siemens") entered into a Development, Licensedevelopment efforts will benefit
all of the Company's products. The Company believes it can increase the diameter
of its wafers while lowering manufacturing costs and Supply Agreement in fiscal 1996 to work jointly onpermitting the development
of a
green LED on silicon carbide substrates, as well as improvements to Cree's blue
LED product. Siemens is a manufacturer of LED lamps for its merchant components
business. In addition to undertaking the joint development program, Siemens paid
a $1.5 million license fee to license certain epitaxial and fabrication
technology from Cree for use inmore complex devices. Key determinants that will enable the manufacture of
greenmore complex devices, such as power semiconductors, are the substrate quality
and blue LEDs.wafer size. Epitaxial thickness, lower defect density and the elimination of
variation are important factors to yield improvement, marketability and lower
-10-
cost. In moving to larger wafer sizes, the Company is focusing on how to
stabilize the process to repeatedly grow larger diameter crystals with minimal
defects. The two-inch wafer size, which Cree introduced in fiscal 1998, is
considered a minimum standard for certain fabrication and development
facilities. Cree is expected to produce three-inch wafers in fiscal 2000 and has
begun development of larger wafer sizes.
During fiscal years 1999, 1998 and 1997, the Company spent $9.4 million, $8.6
million and $9.7 million, respectively, for direct expenditures relating to
research and development activities. Offsetting these expenditures were $6.6
million, $8.2 million and $8.7 million, respectively, of U.S. government funding
for direct and indirect research and development expenses. In addition, certain
customers have also sponsored research activities related to the development of
new products. During fiscal years 1999, 1998 and 1997, customers spent $4.5
million, $3.5 million and $66,000, respectively, for product research and
development activities.
SOURCES OF RAW MATERIALS
- ------------------------
The Company depends on a limited number of suppliers for certain raw materials,
components and equipment used in its SiC products and LEDs, including certain
key materials and equipment used in its crystal growth, wafering, polishing,
epitaxial deposition, device fabrication and device test processes. The Company
generally purchases these limited source items pursuant to purchase orders and
has no guaranteed supply arrangements with its suppliers. In addition, the
availability of these materials, components and equipment to the Company is
dependent in part on the Company's ability to provide its suppliers with
accurate forecasts of its future requirements. The Company endeavors to maintain
ongoing communication with its suppliers to guard against interruptions in
supply and, to date, generally has been able to obtain adequate supplies in a
timely manner from its existing sources. However, any interruption in the supply
of these key materials, components or equipment could have a significant adverse
effect on the Company's operation.
PATENTS AND PROPRIETARY RIGHTS
- ------------------------------
The Company since its inception has been a leader in the development of SiC
materials and devices made using SiC. It seeks to protect its proprietary
technology by applying for patents where appropriate and in other cases by
preserving the technology and related know-how and information as trade secrets.
The Company has also from time to time acquired, through license grants or
assignments, rights to patents on inventions originally developed by others.
At August 2, 1999, the Company owned 46 issued U.S. patents. These patents
expire between 2008 and 2017. Forty-two of the patents are owned by the Company
alone and the remainder, which resulted from research and development agreements
with other firms, are owned jointly with the other parties to such agreements.
The Company also owns corresponding patents and patent applications in certain
foreign countries it considers significant or potentially significant markets.
In addition, the Company owns pending U.S. and foreign patent applications
relating to inventions developed by the Company or acquired from third parties.
The Company holds an exclusive license from North Carolina State University
("N.C. State") to 10 U.S. patents, and to corresponding foreign patents and
applications, that relate to SiC materials and device technology, including a
process to grow single crystal SiC. The license was granted pursuant to an
agreement executed by the Company and N.C. State in 1987. This license gave the
Company a worldwide, fully paid, exclusive license to manufacture, use and sell
products and processes covered by
-11-
the claims of patent applications filed by N.C. State relating to the licensed
inventions. Ten U.S. patents were subsequently issued with respect to the
applications, with expiration dates between 2007 and 2009. Twelve of the foreign
applications have been issued with expiration dates from 2006 to 2013. The U.S.
government holds a non-exclusive license to practice the inventions for
government purposes.
The Company has also includes provisionsentered into other license agreements with N.C. State, and
with the licensing agencies of other universities, under which Cree will supply a portion of
Siemens' requirements for blue and green LEDs and wafer products required for
the manufacture of such LEDs. In September 1996, the Company entered into a
Purchase Agreement with Siemens, pursuanthas
obtained rights to practice inventions claimed in various patent applications
pending in the U.S. and other foreign countries.
For proprietary technology which Siemens agreed to purchase
blue LED chips made using the Company's gallium nitride-on-silicon carbide
technology. In December 1997, the Purchase Agreement was amended to provide for
additional shipments of LED products through December 1998. The Company is currently negotiating an extension of this agreement with Siemens.
Also, in September 1996,not patented or otherwise published, the
Company entered into a Licenseseeks to protect the technology and Technology Transfer Agreementrelated know-how and a related Supply Agreementinformation as
trade secrets and to maintain it in confidence through appropriate
non-disclosure agreements with Shin-Etsu
Handotai Co. Ltd. ("Shin-Etsu")employees and other parties. Pursuantothers to whom the information is
disclosed. There can be no assurance that these agreements the Company granted Shin-Etsu a license towill provide
meaningful protection against unauthorized disclosure or use certain epitaxial and device
fabrication process technology for the manufacture of the Company's
blue LED
productconfidential information or that our proprietary technology and agreedknow-how will
not otherwise become known or independently discovered by others. The Company
also relies upon other intellectual property rights such as copyright where
appropriate.
Because of rapid technological developments in the semiconductor industry, the
patent position of any semiconductor materials or device manufacturer, including
that of the Company is subject to supply silicon carbide wafers requireduncertainties and may involve complex legal
and factual issues. Consequently, there can be no assurance that patents will be
issued on any of the pending applications owned or licensed to manufacture the Company or
that claims allowed by any patents issued or licensed product. The license agreement providedto the Company will not be
contested or invalidated. In the past, the U.S. patent that the Company licenses
from N.C. State relating to growth of SiC was subject to a reissue proceeding;
however, that patent was successfully reissued. Currently, a corresponding
European patent is being opposed, which means that the Company could lose patent
protection in Europe for a paymentthis particular method.
There is likewise no assurance that patent rights owned or exclusively licensed
to the Company will provide significant commercial protection since issuance of
a $2.6 million
license feepatent does not prevent other companies from using alternative, non-infringing
technology. Further, the Company earns a material amount of its revenues in
overseas markets. While the Company holds and royalties based on a percentagehas applied for patent protection
for certain of salesits technologies in these markets, there can be no assurance that
it will obtain protection in all commercially significant foreign markets or
that the Company's intellectual property rights will provide adequate protection
in all such markets.
Frequent claims and litigation involving patents and intellectual property
rights are common in the semiconductor industry. Litigation may be necessary in
the future to enforce the Company's intellectual property rights or to defend
the Company against claims of products
made usinginfringement, and such litigation can be
protracted and costly and divert the licensed technology.
Sales and Distribution
- --------------------------------------------------------------------------------attention of key personnel. There can be no
assurance that third parties will not attempt to assert infringement claims
against the Company with respect to our current or future products. The Company
has been notified from time to time of assertions that its products or processes
may be infringing patents or other intellectual property rights of others. We
cannot predict the occurrence of future assertions of infringement or the extent
to which such assertions may require the Company to seek a license under the
rights asserted. Likewise, we cannot predict the occurrence of future assertions
that may prevent the Company from selling products or result in litigation.
-12-
SALES AND MARKETING
- -------------------
The Company actively markets its blue LED chips domesticallyproducts through targeted mailings,
telemarketing, select advertising and attendance at trade shows. The Company
generally uses an executive sales approach, relying predominantly on the efforts
of senior management and a small direct sales staff for worldwide product sales.
The Company believes that this approach is preferable in a numberview of foreign countries. Becauseits current
customer base and product mix, particularly since the production of lamp and
display products incorporating LED chips is concentrated among a relatively
small number of manufacturers,manufacturers. However, the Company uses an executivedeparts from this approach
for sales approach to market its LED
chips.certain Asian countries. In Japan, the Company markets its LED
products and SiC wafers through its distributors Sumitomo Corporation
("Sumitomo") and Shin-Etsu Handotai Co., Ltd. pursuant to a
Distributorship Agreement signed in 1995.("Shin-Etsu"). The Company marketsalso
uses sales representatives to market its LED products in Hong Kong, China and
SiC
wafer products throughout the rest of the world via a small direct sales staff.Korea. The Company currently distributes the majority of its LED-based modules
directly to OEMs. The OEMs in turn manufacture, sell and generally install
modular based display systems at their customers' sites.
The majority of moving message signs are sold through the Company's
subsidiary, RCD, via a network of international distributors and sales
representatives in South America, the United Kingdom, the Pacific Rim and
Canada. RCD also employs a direct sales program and uses a dealer network to
market a portion of its products in the United States.
The Company also sells SiC crystal materials for use in gemstone applications
directly to C3 under an exclusive supply agreement.
CompetitionCUSTOMERS
- --------------------------------------------------------------------------------
10
---------
During fiscal 1999, revenues from Siemens A.G., C3 and the Department of Defense
each accounted for more than 10% of total revenue. The loss of Siemens, C3, or
the Department of Defense's business would have a material adverse effect on the
results of operations if the Company were unable to replace the lost revenue.
For the year ended June 28, 1998, revenue from Siemens, C3 and the Department of
Defense each accounted for more than 10% of total revenue. For the year ended
June 30, 1997, Siemens and the Department of Defense revenues each accounted for
more than 10% of total revenue. For financial information about foreign and
domestic sales, please see Note #2, "Summary of Significant Accounting Policies"
to the Company's consolidated financial statements included in Item 8 of this
report.
BACKLOG
- -------
As of June 27, 1999, the Company had a firm backlog of approximately $37.1
million consisting of approximately $25.6 million of product orders and $11.5
million of executed research contracts with the U.S. Government. Some of the
funds for executed research contracts with the U.S. Government have been awarded
but may not be appropriated. This compares to a firm backlog level of $12.6
million as of June 28, 1998, which consisted of approximately $7.2 million of
product orders and approximately $5.4 million of executed research contracts
with the U.S. Government. We expect the entire backlog to be filled during
fiscal 2000, with the exception of approximately $5.6 million in U.S. government
funded contracts.
COMPETITION
- -----------
The semiconductor industry is intensely competitive and is characterized by
rapid technological change, price erosion and intense foreign competition. The
Company believes that it currently enjoys a favorable position in the existing and potential emerging
markets for SiC-based products and materials primarily as a result of its
proprietary SiC-based technology. However, the Company faces actual and
potential competition from a number of established domestic and international
compound semiconductor companies. Many of these companies have greater
engineering, manufacturing, marketing and financial capabilitiesresources than the Company.
The Company's primary competition for the blue and green LED productproducts comes from
Nichia Chemical Industries, Ltd. ("Nichia")companies that market blue and Toyoda Gosei Co. Ltd.
("Toyoda"), companies headquartered in Japan,green LEDs fabricated on sapphire substrates.
These competitors market blue and from The Hewlett-Packard
Company ("HP"), who currently market bluegreen
-13-
LED products that are as bright or brighter than the Company's high brightness
blue and green LED device. The sales pricedevices. These companies have historically been successful in
the market for Cree's LED is presently lower than
the standard priceoutdoor display applications because of the product offered by these companies. However, there can
be no assurance that these companies will not offer lower pricing inbrightness demands of
outdoor displays, as well as the future.
Cree's LED product is made by growing epitaxial layers on SiC
substrates for the subsequent fabricationdecreased price sensitivity of the outdoor
display market. Cree believes its brighter blue LED. Competing blue LED
products employ a sapphire substrate. Cree's vertical chip has a lower cost
primarily as a result of its size. Cree's chip has a surface area that is 57% of
the size of the current competitive chip. Thus, SiC substrates can be more
expensive than sapphire and still be competitive on a price per chip basis. The
sapphire substrate requires a larger chip because sapphire is an insulator
material, and as such, requires a horizontal device with both contact points at
the top of the device. The Cree SiC product is a conductive substrate, which
allows one contact point on the top and the other on the bottom, allowing for a
smaller vertical device. Furthermore, because red, amber and yellow-green chips
are vertical devices, Cree's vertical structure facilitates easier use in
existing LED component assembly operations.
The ability of the Companygreen LEDs will enable it to
compete successfully in this market because they can be used in the same
applications at a lower cost than competing products.
The Company believes that its approach to manufacturing blue and green LEDs from
SiC substrates offers a more cost-effective design and process than its
competitors. Cree's smaller chip design, which is compatible with industry
trends for package miniaturization, enables the diode to use less material and
permits more devices to be fabricated on each wafer processed, lowering the cost
per unit. In addition, the Company's industry standard vertical chip structure
allows manufacturers to package the LED on the same production line as other
green, amber and red LEDs, eliminating the need for special equipment necessary
for chips made from sapphire substrates. Furthermore, Cree's SiC-based devices
can withstand a much higher level of electrostatic discharge ("ESD") than
existing sapphire-based products and future markets for its products will depend on factors both within and outside
its control. These factors include, buttherefore are not limited to, success in
manufacturing new higher brightness SiC based products that aremore suitable for
outdoor applications improvementsthat require high ESD emission ratings, such as automotive
applications.
The Company believes that other firms (including certain of our customers) may
seek to existing products, improvements in its
SiC-based process technology, increasing production capacity ofenter the blue and green LED products,
protection of its products by effective utilization of intellectual property
laws, diversity of product line, the rate at which customers incorporate the
Company's components into their products, product introductions by the Company's
competitors, and general domestic and international economic conditions. The
Company; however, expects that price will be a determining factor for many of
its products and it devotes substantial efforts to reduce production costs (See
"Product Development"). There is no assurance that the Company's competitive
position will not be adversely affected by one or more of these factorsmarket in the future, particularlyfuture. For example, Siemens
and Shin-Etsu have licensed certain of our LED technology, which may facilitate
their entrance into our LED markets. We believe that Siemens is currently
producing LEDs using Cree's licensed technology. The market for SiC wafers is
also becoming competitive, as other firms have in view of the fast pace of technological change in the
semiconductor industry.
Sources and Availability of Raw Materials
- --------------------------------------------------------------------------------
The Company depends on single or limited source of suppliers for a
number of raw materials and components used in itsrecent years begun offering
SiC wafer products and LEDs,
including certain key materials and equipment used in its crystal growth,
wafering, polishing, epitaxial deposition, device fabrication, and device test
processes.or announced plans to do so.
ENVIRONMENTAL REGULATION
- ------------------------
The Company generally purchases these single or limited source
materials and components pursuant to
11
purchase orders and has no guaranteed supply arrangements with such suppliers.
In addition, the availability of these materials and components to the Company
is dependent, in part, on the Company's ability to provide its suppliers with
accurate forecasts of its future requirements. Production of many materials used
in semiconductor manufacturing is limited to one or a few manufacturing
facilities worldwide. Disruption of production at one or more of these
facilities represents a risk for the entire semiconductor industry. However,
smaller companies, such as Cree, may be at greater risk than larger companies if
supplies of any materials become scarce as suppliers may favor their larger
customers in allocating their products. Any interruption in the supply of these
key materials or components could have a significant adverse effect on the
Company's operations.
Customers
- --------------------------------------------------------------------------------
During fiscal 1998, sales to Siemens A.G. accounted for more than 10%
of total revenue. The loss of Siemens' business would have a material adverse
effect on the results of operations if the Company were unable to replace the
volume with another customer. In addition, sales to C3, Inc. and the Department
of Defense each comprised more than 10% of total Company revenue for fiscal
1998. For the year ended June 30, 1997, revenue from Siemens and the Department
of Defense each accounted for more than 10% of total revenue. For the year ended
June 30, 1996, Siemens, Sumitomo and the Department of Defense revenues each
accounted for more than 10% of total revenue.
Backlog
- --------------------------------------------------------------------------------
As of June 28, 1998, the Company had a firm backlog of approximately
$12.6 million consisting of approximately $7.2 million of product orders and
$5.4 million of executed research contracts with the U.S. Government. This
compares to a firm backlog level of $17.5 million as of June 30, 1997, which
consisted of approximately $9.2 million of product orders and approximately $8.3
million of executed research contracts with the U.S. Government.
Patents and Proprietary Rights
- --------------------------------------------------------------------------------
The Company has an exclusive license to ten U.S. patents from North
Carolina State University ("NCSU"), and holds 40 additional domestic patents of
its own or owned jointly. Cree licensed 12 foreign patents issued on the same
NCSU technology and holds 19 foreign patents issued on Cree applications which
are counterparts to the U.S. patents. The Company also holds exclusive license
rights to inventions owned by NCSU which are subject to one pending U.S. patent
application and two foreign applications, which are counterparts of the U.S.
patent applications. Cree has 27 patent applications of its own pending in the
United States and also has 79 foreign patent applications pending. In addition
to its patent rights, the Company relies upon certain proprietary know-how and
trade secrets in its manufacturing process and has entered into non-disclosure
agreements to protect its proprietary technology with both employees and parties
outside of the Company.
The Company earns a material amount of its revenues in overseas
markets. See "Customers". While the Company has applied for patent protection
for certain of its technologies and products in some of these markets, there can
be no assurance that such markets will be subject to the Company's intellectual
property rights.
12
The NCSU License. In 1987, the Company entered into a license agreement
with NCSU pursuant to which the Company was granted a worldwide, fully paid,
exclusive license to manufacture, use, and sell products and processes covered
by the claims of ten U.S. patent applications filed by NCSU relating to SiC
materials and SiC-based semiconductor devices, some of which also have been
filed in foreign countries. Ten patents were subsequently issued with respect to
eight of those applications, with expiration dates between 2007 and 2009. Twelve
of the foreign filings have been issued with expiration dates from 2006 through
2012. Under the terms of the license, the U.S. Office of Naval Research has
retained an interest in the licensed technology for certain military
applications.
Cree's Patents. Since its inception, the Company has been granted 40
U.S. patents of its own or jointly owned. These patents expire between 2008 and
2016. The Company has filed a number of these patent applications in foreign
countries, 17 of which have been issued. In addition, the Company has, in
the past, entered into joint research and development programs to develop new
SiC-based devices. These efforts have resulted in four jointly-owned patents,
one with Purdue University, two joint patents with General Electric Corporation,
and one joint patent with NCSU.
Although the Company has not received any claims that its products
infringe on the proprietary rights of third parties, there can be no assurance
that third parties will not assert infringement claims against the Company in
the future with respect to current or future products or that such assertion may
not require the Company to enter into royalty arrangements, prevent the Company
from selling products, or result in protracted or costly litigation.
Because of rapid technological developments in the semiconductor
industry and the broad and rapidly developing field of patent law, the patent
position of any semiconductor device manufacturer, including that of the
Company, is subject to uncertainties and may involve complex legal and factual
issues. Consequently, although the Company holds certain patents, is licensed
under other patents, and is currently pursuing additional patent applications,
there can be no assurance that patents will be issued from any pending
applications or that claims allowed by any existing or future patents issued or
licensed to the Company will not be challenged, invalidated, or circumvented, or
that any rights granted thereunder will provide adequate protection to the
Company. Moreover, the Company may be required to participate in interference
proceedings to determine the priority of inventions, which could result in
substantial costs to the Company.
Environmental Regulation
- --------------------------------------------------------------------------------
The Company uses and disposes of hazardous substances and wastes in its
manufacturing and research and development activities and is thus subject to a variety of federal, stategovernmental regulations pertaining to
chemical and local government lawswaste discharges and regulations related toother aspects of our manufacturing process.
For example, we are responsible for the storage,management of the hazardous materials we
use and dispose of hazardous waste resulting from our manufacturing process. The
proper handling and disposal of such materials. The Company is also subjecthazardous material and waste requires us to
laws and regulations related to the discharge of environmental pollutants. The
Company believes that it iscomply with certain government regulations. We believe we are in full compliance
with all applicable laws regulating
hazardous materials and environmental pollutants and is not presently aware ofsuch regulations, but any contamination at any of its premises for which it could be responsible under
applicable law. However, the failure to comply, with presentwhether intentional or
future laws or
regulations relating to such materials could result in fines or other
liabilities being imposed on the Company, or in suspension or cessation of
operations, which eventsinadvertent, could have a materialan adverse effect on the Company's
business and prospects.
Employeesour business.
EMPLOYEES
- --------------------------------------------------------------------------------
13
---------
As of June 28, 1998,27, 1999, the Company employed 248390 people, all of which are located
in the United States. None of the Company's employees are represented by a labor
union or subject to collective bargaining agreements. The Company believes
relations with its employees are strong.
Risk FactorsCERTAIN BUSINESS RISKS AND UNCERTAINTIES
- --------------------------------------------------------------------------------
Ownership----------------------------------------
OUR OPERATING RESULTS MAY FLUCTUATE SIGNIFICANTLY AND WE MAY NOT BE ABLE TO
MAINTAIN OUR EXISTING GROWTH RATE.
Although we have had significant revenue and earnings growth in recent quarters,
we may not be able to sustain these growth rates and we may experience
significant fluctuations in our revenue and earnings in the future.
-14-
Our operating results will depend on many factors, including the following:
o our ability to develop, manufacture and deliver products in a timely
and cost-effective manner;
o whether we encounter low levels of usable product produced during each
manufacturing step (our "yield");
o our ability to expand our production of SiC wafers and devices;
o demand for our products or our customers' products;
o competition; and
o general industry and global economic conditions.
Our future operating results could be adversely affected by these or other
factors. If our future operating results are below the expectations of stock
market analysts or our investors, our stock price may decline.
IF WE EXPERIENCE POOR PRODUCTION YIELDS, OUR OPERATING RESULTS MAY SUFFER.
Our SiC products are manufactured using technologies that are highly complex.
Our customers incorporate our products into high volume applications such as
automotive dashboards, wireless handsets, full color video displays and
gemstones, and they insist that our products meet exact specifications for
quality, performance and reliability.
The number of usable crystals, wafers and devices that result from our
production processes can fluctuate as a result of many factors, including but
not limited to the following:
o impurities in the materials used;
o contamination of the Company's securitiesmanufacturing environment;
o equipment failure, power outages or variations in the manufacturing
process;
o losses from broken wafers or other human error; and
o defects in packaging.
Because many of our manufacturing costs are fixed, if our yields decrease our
operating results would be adversely affected. For this reason, we are
constantly trying to improve our yields. In the past, we have experienced
difficulties in achieving acceptable yields on new products, which has adversely
affected our operating results. We may experience similar problems in the future
and we cannot predict when they may occur or their severity. These problems
could significantly affect our future operating results.
IF WE ARE UNABLE TO PRODUCE ADEQUATE QUANTITIES OF OUR HIGH BRIGHTNESS LEDs, OUR
OPERATING RESULTS MAY SUFFER.
We believe that higher volume production of high brightness blue and green LEDs
will be important to our future operating results. Achieving greater volumes
requires improved production yields for these products. Successful production of
these products is subject to a number of risks, including the following:
Production Efficiencyo our ability to consistently manufacture these products in volumes large
enough to cover our fixed costs and Availability of Raw Materials
The Company must continuesatisfy our customers' requirements;
and
o our ability to improve its productionour yields in order toand reduce costs. Production yield problems or missed efficiencies may have an
adverse effect on the Company's operations. Shouldcosts associated with the
Company experience
protracted problems in the production of its key components or the operation of
its proprietary manufacturing systems, its ability to deliver its products could
be materially impacted. Such problems often occur as new products are introduced
or improvements are made to existing products. As the Company expects several
significant development projects to be completed in fiscal 1999, the Company may
be particularly vulnerable to this risk. The Company is also dependent on a
limited source of suppliers for a number of raw materials and components used in
its SiC wafer products and LEDs. An interruption in the supplymanufacture of these items
could cause the Company's manufacturing effortsproducts.
Our inability to be damagedproduce adequate quantities of our high brightness blue and
result in
customer dissatisfaction.
Concentration of Business
The Company relies on a small number of customers for much of its
sales. At present, the majority of the LED sales are made to Siemens pursuant to
the parties' Purchase Agreement executed in September 1996 and amended in
December 1997. This agreement calls for shipments through December 1998, subject
to certain rescheduling provisions. Failure to extend this agreement couldgreen products would have a material adverse effect on our business, results of
operations and financial condition.
-15-
OUR OPERATING RESULTS ARE SUBSTANTIALLY DEPENDENT ON THE DEVELOPMENT OF NEW
PRODUCTS BASED ON OUR CORE SIC TECHNOLOGY.
Our future success will depend on our ability to develop new SiC solutions for
existing and new markets. We must introduce new products in a timely and
cost-effective manner and we must secure production orders from our customers.
The development of new SiC products is a highly complex process, and we have
historically experienced delays in completing the businessdevelopment and prospectsintroduction
of new products. Products currently under development include high power radio
frequency and microwave devices, power devices, blue laser diodes and high
temperature devices. The successful development and introduction of these
products depends on a number of factors, including the following:
o achievement of technology breakthroughs required to make commercially
viable devices;
o the accuracy of our predictions of market requirements and evolving
standards;
o acceptance of our new product designs; o the availability of qualified
development personnel;
o our timely completion of product designs and development;
o our ability to develop repeatable processes to manufacture new products in
sufficient quantities for commercial sales; and
o acceptance of our customers' products by the market.
If any of these or other factors become problematic, we may not be able to
develop and introduce these new products in a timely or cost-efficient manner.
WE DEPEND ON A FEW LARGE CUSTOMERS.
Historically, a substantial portion of our revenue has come from large purchases
by a small number of customers. We expect that trend to continue. For example,
for fiscal 1999 our top five customers accounted for 81% of our total revenue.
Accordingly, our future operating results depend on the success of our largest
customers and on our success in selling large quantities of our products to
them. The concentration of our revenues with a few large customers makes us
particularly dependent on factors affecting those customers. For example, if
demand for their products decreases, they may stop purchasing our products and
our operating results will suffer. If we lose a large customer and fail to add
new customers to replace lost revenue, our operating results may not recover.
WE FACE CHALLENGES RELATING TO EXPANSION OF OUR PRODUCTION AND MANUFACTURING
FACILITY.
In order to increase production at our new facility, we must add critical new
equipment, move existing equipment and complete the construction and upfit of
buildings. Expansion activities such as these are subject to a number of risks,
including unforeseen environmental or engineering problems relating to existing
or new facilities or unavailability or late delivery of the Company.
Dependence on one or a few customers may require the Company to agree to
unfavorable contract termsadvanced, and conditions that could cause contracts to be
unprofitable. Likewise, the failure of the Company to diversify its customer
base could limit the prospects for the LED business.
Foreign Sales
The Company has, and is expected to continue to have, a substantial
percentage of its sales to foreign companies, primarily in Asia and Europe.
There can be no assurance that the Company's current intellectual property
position will be enforceable in foreign countries to the extent it is
enforceableoften
customized, equipment used in the United States. In addition, the Company's international sales
may be subject to government controlsproduction of our products, and delays in
bringing production equipment on-line. These and other risks including export
licenses, federal restrictions, changes in demand resulting from currency
fluctuations, political instability, trade restrictions, changes in tariffsmay affect the
construction of new facilities, which could adversely affect our business,
results of operations and collection of accounts receivable. If the current slowdown in the economies of
certain Asian countries worsens, the Company may be materially adversely
affected.
Research and Development
To remain competitive, the Company must continue to investfinancial condition.
THE MARKETS IN WHICH WE OPERATE ARE HIGHLY COMPETITIVE.
The market for our products is highly competitive. Although we believe our
SiC-based LEDs offer substantial resources in research and development. The Company's prospects for both
near-term and long-term success are substantially dependent on its ability to
continue to increase the performance of its LED products and to increase
production efficiency. The successful introduction of the brighteradvantages, competitors currently sell blue and
green productsLEDs made from sapphire wafers that
-16-
are brighter than the high brightness LEDs we currently produce. In addition, we
believe that other firms (including certain of our customers) may seek to enter
the blue and the expected
14
higher yield and lower costs of the conductive buffer product, is very important
for the Company to achieve its goals for fiscal 1999. Furthering the need for
enhanced efficiency, is the expected declinegreen LED market in the average sales pricefuture. For example, Siemens and Shin-Etsu
license certain of our LED technology, which may facilitate their entrance into
our LED markets. The market for the
LEDSiC wafers is also becoming competitive as other
firms have in recent years begun offering SiC wafer products in fiscal 1999. Without the introduction of the brighter LED
products and yield and volume efficiencies of the conductive product, the
Companyor announced plans
to do so.
Also, other firms may not maintain or realize growth in the LED business. In addition, the
Company must also invest resources toward the introduction of microwave products
in fiscal 1999. See "Product Development". Near-term results may suffer due to a
lag between investment in development, marketing and production, and revenues
derived from the investment even ifdevelop new or improved products are a long-term
success.
The patents and other proprietary rights of the Company may not
prevent the competitors of the Company from developing noninfringing technology
andenhanced products that are more attractive to customerseffective
than the technology and
productsthose of the Company. These firms may develop technology that produces
commercial products with characteristics similar to SiC-based products, but at a
lower cost. Many existing and potential competitors have far greater financial,
marketing and other resources than we do. We believe that present and future
competitors will aggressively pursue the development and sale of competing
products. We also expect significant competition for products we are currently
developing, such as those for use in microwave communications.
We expect competition to increase. This could mean lower prices for our
products, reduced demand for our products and a corresponding reduction in our
ability to recover development, engineering and manufacturing costs. Any of
these developments could have an adverse effect on our business, results of
operations and financial condition.
WE RELY ON A FEW KEY SUPPLIERS.
We depend on a limited number of suppliers for certain raw materials, components
and equipment used in manufacturing our SiC products, including key materials
and equipment used in critical stages of our manufacturing processes. We
generally purchase these limited source items with purchase orders, and we have
no guaranteed supply arrangements with such suppliers. If we were to lose such
key suppliers, our manufacturing efforts could be hampered significantly.
Although we believe our relationship with our suppliers is good, we cannot
assure you that we will continue to maintain good relationships with such
suppliers or that such suppliers will continue to exist.
IF GOVERNMENT AGENCIES OR OTHER CUSTOMERS DISCONTINUE THEIR FUNDING FOR OUR
RESEARCH AND DEVELOPMENT OF SIC TECHNOLOGY, OUR BUSINESS MAY SUFFER.
In the past, government agencies and other customers have funded a significant
portion of our research and development activities. If this support is
discontinued or reduced, our ability to develop or enhance products could be
limited and our business, results of operations and financial condition could be
adversely affected.
LIMITATIONS ON THE PROTECTION OF OUR INTELLECTUAL PROPERTY.
Our intellectual property position is based in part on patents owned by us and
patents exclusively licensed to us by N.C. State. The technologylicensed patents give us
rights to our SiC crystal growth process. The issued U.S. patents we own will
expire between 2008 and products2017. The expiration dates on the U.S. patents we
license from N.C. State run from 2007 to 2009. We have obtained a number of
corresponding patents and patent applications in certain foreign jurisdictions.
We intend to continue to file patent applications in the future, where
appropriate, and to pursue such applications with U.S. and foreign patent
authorities, but we cannot be sure that any other patents will be issued on such
applications or that our patents will not be contested. In the past, the U.S.
patent that the Company licenses from N.C. State relating to growth of SiC was
subject to a reissue proceeding; however, that patent was successfully reissued.
Currently, a corresponding European patent is being opposed, which means that
the Company could lose
-17-
patent protection in Europe for this particular method. Also, because issuance
of a valid patent does not prevent other companies from using alternative,
non-infringing technology, we cannot be determinedsure that any of our patents (or patents
issued to infringe theothers and licensed to us) will provide significant commercial
protection. In addition to patent protection, we also rely on trade secrets and
other non-patented proprietary information relating to our product development
and manufacturing activities. We try to protect this information with
confidentiality agreements with our employees and other parties. We cannot be
sure that these agreements will not be breached, that we would have adequate
remedies for any breach or that our trade secrets and proprietary know-how will
not otherwise become known or independently discovered by others.
OUR OPERATIONS COULD INFRINGE UPON THE INTELLECTUAL PROPERTY RIGHTS OF OTHERS.
Other companies may hold or obtain patents on inventions or othermay otherwise claim
proprietary rights to technology necessary to our business. We cannot predict
the extent to which we may be required to seek licenses or, if required, whether
such licenses will be offered or offered on acceptable terms or that disputes
can be resolved without litigation. Litigation to determine the validity of
others. In
addition, defending such an infringement, claimor claims alleged by third parties, could haveresult in significant
expense to us and divert the efforts of our technical and management personnel,
whether or not the litigation is ultimately determined in our favor.
WE ARE SUBJECT TO RISKS FROM INTERNATIONAL SALES.
Sales to customers located outside the U.S. accounted for about 62%, 74% and 79%
of our revenue in fiscal 1999, 1998 and 1997, respectively. We expect that
revenue from international sales will continue to be a significant part of our
total revenue. International sales are subject to a variety of risks, including
risks arising from currency fluctuations, the emergence of the Euro, trading
restrictions, tariffs, trade barriers and taxes. Also, future U.S. Government or
military export restrictions could limit or prohibit sales to customers in
certain countries because of their uses in military or surveillance
applications. Because all of our foreign sales are denominated in U.S. dollars,
our products become less price competitive in countries with currencies that are
low or are declining in value against the U.S. dollar. Also, we cannot be sure
that our international customers will continue to place orders denominated in
U.S. dollars. If they do not, our reported revenue and earnings will be subject
to foreign exchange fluctuations.
WE FACE RISKS CONCERNING YEAR 2000 ISSUES.
We are evaluating all of our internal computers, computer equipment and other
equipment with embedded technology against Year 2000 concerns. Although we
believe our planning efforts are adequate to address our Year 2000 concerns, it
is still possible that we could experience negative consequences and material
cost caused by undetected errors or defects in the technology used in our
internal systems. Our most significant Year 2000 risk is that the systems of
other parties on which we rely, specifically our key suppliers, will not be
compliant on a timely basis. Any disruption in delivery of supplies to us that
is caused by a third party's failure to address Year 2000 issues would affect
our ability to manufacture our products, which could result in a material
adverse impacteffect on our business, operating results and financial condition. At
this time, we are unable to estimate the most likely worst-case effects of the
arrival of the Year 2000.
-18-
Item 2. Properties
The Company operates its own facilities in Durham, North Carolina. Direct
control over SiC crystal growth, wafering, epitaxial deposition, device
fabrication and test operations allows the Company even if the claim were found to lack merit.
Dependence on Contracts With the U.S. Government
Over the past several years,shorten its product design
and production cycles and to protect its proprietary technology and processes.
In November 1997, the Company has been awardedacquired its present manufacturing facility, a
number of
contracts from agencies of the United States government for purposes of
developing SiC material and SiC-based semiconductor devices. Government policy
is constantly changing, therefore, there can be no assurance that the Company
will enter into any additional government contracts, or, if such contracts are
entered into, that they will be profitable or produce contract revenue. In
addition, there can be no assurance that after any such contracts are entered
into, changing government regulations will not significantly alter the benefits
of such contracts that can be expected to inure to the Company. Cutbacks30-acre industrial site in or
reallocations of Federal spending, including changes which could be proposed or
implemented in the future, could have a material adverse impact on the
Company's results of operations, as well as its ability to implement its
research and development programs.
Item 2. Description of Property
The Company purchased real propertyDurham, North Carolina, consisting of approximately 30
acres of land on which exists a 162,000139,000
square foot production facility and a
total of 35,00033,000 square feet of service and warehouse
buildings. This propertyCree is located in Durham County, North Carolina, incurrently constructing an addition to the vicinity of the Research
Triangle Park. The purchase price for the land and buildings was $3 million.
Since the acquisition of thismain production
facility the Company has invested approximately
$8.4 million in building upfits and improvements.containing 42,000 square feet. The Company plansalso recently purchased a
79-acre site close to relocate
the majority of its operations to thispresent facility over the next few years.for potential future expansion.
The Company currently leases space for some of its manufacturing and primary
research and development facilities,
which occupy 21,900 1,900 and 1,900 square feet respectively, in the same building in Durham, North Carolina. The leases
expireThis lease expires in
December 2001, May 1999 and October 1998, respectively.2001. In addition, the Company also leases approximately 13,200 square
feet in a separate building in Durham, North Carolina, that is expected to be
used for its device fabricationresearch and test processes.development projects. This lease term expires in August 2000.
The Company also leases a small administrative office. This lease expires in
December 1999.
Item 3. Legal Proceedings
The Company is not a party to any material litigation and is not aware of any
pending or threatened litigation that could have a material adverse effect
either upon the Company's business, operating results or financial condition.
Item 4. Submission of Matters to a Vote of Security Holders
15
No matters were submitted to a vote of security holders during the fourth
quarter of fiscal 1998.1999.
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
Common Stock Market Information. The Company's common stock is traded in the
NASDAQ National Market System and is quoted under the symbol "CREE". The following
table sets forth, for the quarters indicated, the high and low bid prices as
reported by NASDAQ. Quotations represent interdealer prices without an
adjustment for retail markups, markdowns or commissions and may not represent
actual transactions.
FY 19981999* FY 19971998*
-------- --------
High Low High Low
---- --- ---- ---
First Quarter $20-1/2 $11-3/4 $15-3/4 $8-1/4$ 8.750 $ 5.250 $10.250 $ 5.875
Second Quarter $29-1/5 $15-5/8 $14 $8-7/8$23.500 $ 6.813 $14.750 $ 7.813
Third Quarter $19-5/8 $13-1/2 $15-7/8 $9-3/8$26.625 $15.125 $9.813 $ 6.750
Fourth Quarter $17-5/8 $14 $15-1/8 $9-1/2$36.688 $18.625 $8.813 $ 7.000
*As adjusted for the two-for-one split effective on July 26, 1999.
-19-
Holders and Dividends. There were approximately 381387 holders of record of the
Company's Common Stockcommon stock as of August 7, 1998.2, 1999.
The Company has never paid cash dividends on its Common Stock and does not
anticipate that it will do so in the foreseeable future. There are no
contractual restrictions in place that currently materially limit, or are likely
in the future to materially limit, the Company from paying dividends on its
common stock, but applicable state law may limit the payment of dividends. The
present policy of the Company is to retain earnings, if any, to provide funds
for the operation and expansion of its business.
Item 6. Selected Financial Data
The consolidated statement of operations data set forth below with respect to
the years ended June 27, 1999, June 28, 1998 and June 30, 1997, and 1996, and the
consolidated balance sheet data at June 28, 199827, 1999 and June 30, 199728, 1998 are derived
from, and are qualified by reference to, the audited consolidated financial
statements included elsewhere in this report and should be read in conjunction
with those financial statements and notes thereto. The consolidated statement of
operations data for the years ended June 30, 19951996 and 19941995 and the consolidated
balance sheet data at June 30, 1997, 1996 1995 and 19941995 are derived from audited
consolidated financial statements not included herein. 16
Selected Financial Data
(in thousands, except per share data)
Years Ended
-----------------------------------------------------------
June 28, June 30, June 30, June 30, June 30,
1998 1997 1996 1995 1994
-------- -------- -------- -------- --------
Statement of Operations Data:
Product revenue, net $ 34,891 $ 19,823 $ 9,689 $ 5,989 $ 3,534
Contract revenue, net 7,640 6,535 3,945 3,011 3,956
License fee income -- 2,615 1,423 -- --
-------- -------- -------- -------- --------
Total revenue 42,531 28,973 15,057 9,000 7,490
Net income (loss) from continuing operations 6,275 3,542 243 (17) (431)
Basic earnings (loss) per common share $ 0.49 $ 0.28 $ 0.02 $ 0.00 $ (0.04)
Dilutive earnings (loss) per common share $ 0.47 $ 0.27 $ 0.02 $ 0.00 $ (0.04)
Weighted average shares outstanding 13,493 13,126 12,615 10,367 10,337
Years Ended
-----------------------------------------------------------
June 28, June 30, June 30, June 30, June 30,
1998 1997 1996 1995 1994
-------- -------- -------- -------- --------
Balance Sheet Data:
Working Capital $ 27,603 $ 21,013 $ 18,596 $ 9,971 $ 11,006
Total assets 72,724 50,137 43,796 20,924 20,018
Long-term obligations 10,804 1,638 -- -- 14
Shareholders' equity $ 54,865 $ 45,125 $ 40,672 $ 19,504 $ 19,334
* The Company has not declared a dividend on commonAll share amounts have
been restated to reflect the Company's two-for-one stock since its inception
** The years endedsplit effective July
26, 1999.
Selected Consolidated Financial Data
(In thousands, except per share data)
Years Ended
--------------------------------------------
June 27, June 28, 1998 and June 30, June 30, June 30,
1999 1998 1997 1996 and 1995
include the
Company's wholly owned subsidiary, Real Color Displays, Inc.
17-------- -------- -------- -------- --------
Statement of Operations Data:
Product revenue, net $53,464 $34,891 $ 19,823 $ 9,689 $ 5,989
Contract revenue, net 6,586 7,640 6,535 3,945 3,011
License fee income -- -- 2,615 1,423 --
--------------------------------------------
Total revenue 60,050 42,531 28,973 15,057 9,000
Income (loss) from continuing 12,702 6,275 3,542 243 (17)
operations
Net income per share, basic $0.47 $0.24 $0.14 $0.01 $0.00
Net income per share, dilutive $0.45 $0.23 $0.13 $0.01 $0.00
Weighted average shares 28,432 26,987 26,251 25,230 20,734
outstanding
Years Ended
--------------------------------------------
June 27, June 28, June 30, June 30, June 30,
1999 1998 1997 1996 1995
-------- -------- -------- -------- --------
Balance Sheet Data:
Working capital $60,222 $27,603 $21,013 $18,596 $ 9,971
Total assets 144,217 72,724 50,137 43,796 20,924
Long-term obligations 4,650 10,804 1,638 -- --
Shareholders' equity $130,022 $54,865 $45,125 $40,672 $19,504
-20-
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Cautionary Statement Identifying Important Factors That Could CauseAll statements, trend analysis and other information contained in the Company's Actual Resultsfollowing
discussion relative to Differ From Those Projectedmarkets for our products and trends in Forward Looking
Statements
Pursuant to the "safe harbor" provisions of the Private Securities
Litigation Reform Act of 1995, readers of this report are advised that this
document contains bothrevenue, gross
margins, and anticipated expense levels, as well as other statements, of historical factsincluding
words such as "may," "will," "anticipate," "believe," "plan," "estimate,"
"expect," and forward looking"intend" and other similar expressions constitute forward-looking
statements. Forward lookingThese forward-looking statements are subject to certainbusiness and
economic risks and uncertainties, which could causeand our actual results toof operations may
differ materially from those indicated bycontained in the forward lookingforward-looking statements.
Examples of forward looking
statementsFactors that could cause or contribute to such differences include, but are not
limited to, (i) projectionsthose discussed in "Certain Business Risks and Uncertainties" in
Item 1 of revenues, income
or loss, earnings per share, capital expenditures, dividends, capital structure
andthis report, as well as other financial items, (ii) statements of the plans and objectives of the
Company or its management or Board of Directors, including product enhancements,
or estimates or predictions of actions by customers, suppliers, competitors or
regulatory authorities, (iii) statements of future economic performance, and
(iv) statements of assumptions underlying other statements and statements about
the Company and its business.
This report also identifies important factors which could cause actual
results to differ materially from those indicated by the forward looking
statements. These risks and uncertainties includereferenced in
this report.
OVERVIEW
- --------
We are the world leaders in developing and manufacturing semiconductor materials
and electronic devices made from SiC. We recognize product revenue at the time
of shipment or in accordance with the terms of the relevant contract. We
recognize the largest portion of our revenue from the sale of blue and green LED
products. We offer LEDs at two brightness levels- high brightness blue and green
products and standard blue products. Our LED devices are utilized by end users
for automotive backlighting, LCD backlighting (including wireless handsets),
indicator lamps, miniature white lighting, indoor sign and arena displays,
outdoor full color stadium displays, traffic signals and other lighting
applications. LED products represented 51% of our revenue in fiscal 1999 and 48%
in fiscal 1998.
We also derive revenue from the sale of advanced materials made from SiC that
are used primarily for research and development. We also sell SiC crystals to
C3, which incorporates them in gemstone applications. During late fiscal 1998
and fiscal 1999, C3 purchased equipment from us, which has more than doubled the
capacity for the production of crystals for C3. Sales of advanced materials made
from SiC represented 38% of our revenue in fiscal 1999 and approximately 34%
during fiscal 1998.
The balance of our revenue, 11% for fiscal 1999 and 18% for fiscal 1998 is
derived from government contract funding. Under various programs, U.S.
Government entities further the development of our technology by supplementing
our research and development efforts. All resulting technology remains our
property after the completion of the contract, subject to certain license rights
retained by the government. Contract revenue includes funding of direct research
and development costs and a portion of our general and administrative expenses
and other operating expenses for contracts under which we expect funding to
exceed direct costs over the life of the contract. For contracts under which we
anticipate that direct costs will exceed amounts to be funded over the life of
the contract (i.e., certain cost-share arrangements), we report direct costs as
research and development expenses with related reimbursements recorded as an
offset to those expenses.
In June 1999, Cree announced the first of a family of RF and microwave
transistor products made from SiC and designed for use in a variety of power
amplification processes. A second phase of transistor products is expected to be
available in fiscal 2000. The Company expects that these products will be
marketed to a variety of amplifier producers, including wireless base stations
and digital broadcast applications. While distribution of samples will commence
in early fiscal 2000, during fiscal 2000 the Company believes that these
products will be sold in limited quantities as design cycles for the target
applications are generally several months. There can be no assurance that
customers will be able to
-21-
develop applications in the near future that will require commercial production
of the Company's abilityRF products or that such products will be successful in the
market.
RESULTS OF OPERATIONS
- ---------------------
The following table shows our statement of operations data expressed as a
percentage of total revenue for the periods indicated:
YEARS ENDED
-----------------------------------
June 27, June 28, June 30,
1999 1998 1997
-------- -------- --------
Revenue:
Product revenue, net...... 89.0% 82.0% 68.4%
Contract revenue, net..... 11.0 18.0 22.6
License fee income........ -- -- 9.0
-------- -------- --------
Total revenue.......... 100.0 100.0 100.0
Cost of Revenue:
Product revenue, net...... 44.9 51.1 46.2
Contract revenue, net..... 8.2 14.7 19.7
-------- -------- --------
Total cost of revenue.. 53.1 65.8 65.9
-------- -------- --------
Gross margin................. 46.9 34.2 34.1
Operating expenses:
Research and development.. 7.4 4.2 6.3
Sales, general and
administrative........... 10.1 9.6 14.9
Other expense............. 1.8 1.2 2.2
-------- -------- --------
Income from operations.... 27.6 19.2 10.7
Interest income, net......... 1.8 1.7 2.1
-------- -------- --------
Income before income taxes 29.4 20.9 12.8
Income tax expense........... 8.2 6.1 0.6
-------- -------- --------
Net income................ 21.2% 14.8% 12.2%
======== ======== ========
FISCAL YEARS ENDED JUNE 27, 1999 AND JUNE 28, 1998
Revenue
Revenue grew 41% from $42.5 million in fiscal 1998 to complete development of and successfully introduce new LED and microwave
products,$60.1 million in fiscal
1999. This increase was attributable to lower LED and wafer costs,higher product revenue, which rose 53%
from $34.9 million in fiscal 1998 to gain$53.5 million in fiscal 1999. This increase
in product revenue was a larger customer base, and to
increase product yields and wafer size, possible price competition, potential
failure to obtain expected volume increases from existing customers, potential
infringement claims by third parties, potential inabilityresult of the Company62% rise in sales of our LED products and
58% increase in materials revenue in fiscal 1999 compared to enforce its intellectual property rights against others, availability and
continuation of U.S. government funded research contracts, possible delaysfiscal 1998,
respectively.
Growth in LED volume resulted from the introduction of otherthe new high brightness
devices and improvements in the product design of and strong demand for the
standard brightness product. While we continue to improve our manufacturing
process and yields on our high brightness products, we must continue to
significantly increase our production output to meet the growing demands of our
customers. We believe that our LED products are particularly attractive to the
marketplace due to our low prices and
delays-22-
industry standard vertical structure. During fiscal 1999, LED volume grew 160%
while average sales prices declined 38%.
We expect that in customer acceptanceorder to increase market demand for all of our LED products,
or services and other factors, which are described herein. See Item 1,
Business, Risk Factors.
On September 24, 1997, the Board of Directors of Cree Research, Inc.
changed the Company'swe must continue to lower average sales prices, although pricing is anticipated
to be more stable in fiscal year 2000 than prior years. Historically, we have
been successful in matching lower sales prices with lower costs. During fiscal
2000, we plan to focus on reducing costs through higher production yields and
from the twelve months ending June 30,greater volumes as fixed costs are spread over a greater number of units.
In September 1996, we entered into an agreement with Siemens where Siemens
agreed to a 52
or 53 week year endingpurchase our blue LED chips. In December 1998, this agreement was
amended to provide for additional shipments of LED products through September
1999 and was assigned to an indirect subsidiary of Siemens, OSRAM Opto
Semiconductors GmbH & Co. ("Osram"), effective as of January 1, 1999. This
contract calls for declining prices based on the last Sunday in the month of June. The Company's
1998 fiscal year extended for the period from July 1, 1997 to June 28, 1998.
Results of Operations
For the fiscal year ended June 28, 1998, Cree posted record revenue and
net income of $42,531,000 and $6,275,000, or $0.47 per diluted share,
respectively. These results reflect an increase in the number of units
shipped. This pricing structure is common with customers in the semiconductor
industry and prior agreements with Siemens. Siemens (including its Osram
subsidiary) accounted for 37% of our revenue for fiscal 1999 and net income of
$13,558,000 and $2,733,000, respectively, over the prior year. Product revenue,40% in fiscal
1998. We are currently negotiating a new purchase agreement with Osram.
Our high brightness LED products, which includes LED, wafer and other material sales, module display products and
moving message sign sales, reflects a 76% increase over fiscal 1997 results.
Comparatively, product revenue also increased 105%were introduced during fiscal 1997 over 1996
amounts.
Product1999,
continue to be ramped up to high volume production in our manufacturing
facility. During the fourth quarter of fiscal 1999, revenue from high brightness
products made up more than 25% of total LED revenue. We believe sales from these
products will surpass our standard brightness product during fiscal year 2000;
however, there can be no assurance that the product volume will increase or
yield improvements will be made to do so.
Revenue attributable to sales of SiC material was 58% higher in fiscal 1999 than
in the same period of fiscal 1998 due to a significant increase in sales to C3
for gemstone applications and strong demand for wafer products. During fiscal
1998, C3 was in initial stages of operation; therefore, unit sales were limited.
Revenue from sales of SiC wafers were higher in fiscal 1999 as compared to
fiscal 1998, due to quality improvements in wafers, along with the availability
of the larger two-inch wafer during fiscal 1999.
During fiscal 1999, sales from our displays business declined 96% from the prior
year period as we have chosen to discontinue this product line. Contract revenue
received from U.S. Government agencies also declined 14% during fiscal 1999
compared to fiscal 1998, as a significant contract that funded optoelectronic
research was exhausted in early fiscal 1999. We anticipate contract revenue to
increase slightly in fiscal 2000 as additional contract awards have been
received in late fiscal 1999.
Gross Profit
Gross margin climbed to 47% of revenue during fiscal 1999 as compared to 34%
during fiscal 1998. This increase is predominantly attributable to design and
manufacturing improvements that occurred over the past year resulting in
significant reductions in cost. With the introduction of the new conductive
buffer LED technology in the fourth quarter of fiscal 1998, we were able to
significantly lower costs of production due to fewer manufacturing steps
required with the new chip structure and improved yield. During the first six
months of fiscal 1998, we introduced a smaller LED chip size and, in December
1997, we began to fabricate devices on a larger two-inch wafer. During much of
fiscal 1998, we were still in the process of establishing these new
manufacturing designs and had not achieved production efficiency. In addition,
the larger two-inch wafer had not been in full production for much of fiscal
1998; therefore, average die yields were significantly lower.
-23-
During fiscal 1999, margins realized on the high brightness products were lower
than those derived from our standard blue LED product, as the yield from the
manufacturing process was less than our standard product. Historically, we have
experienced lower margins with many new product introductions. While we continue
to make improvements to output and yield, the high brightness products may
continue to pressure margins in the short term if we are not able to meet our
yield objectives.
Average wafer costs for SiC material sales also declined 32% during fiscal 1999
over the comparative period due to more efficient processes and improved yield.
Research and Development
Research and development expenses increased 150% in fiscal 1999 to $4.4 million
from $1.8 million in fiscal 1998. Much of this increase was caused by
significantly higher costs for the initial development of the new high
brightness LED products. In May of 1999, the company signed a $2.6 million
agreement with MVIS for the development of edge-emitting LEDs and blue laser
diodes. As development costs are incurred under this contract, funding from MVIS
is offset against these expenses. During fiscal 1999, approximately $0.5 million
of funding from MVIS was offset against research and development expenses. The
remaining $2.1 million of funding is anticipated to be applied to research and
development expenses in fiscal 2000. We expect that including the offset of MVIS
funds in fiscal 2000, research and development expenses will remain relatively
stable compared to fiscal 1999 amounts.
Sales, General and Administrative
Sales, general and administrative expenses increased 47% in fiscal 1999 to $6.1
million from $4.1 million in the fiscal 1998 due primarily to the general growth
in our business. In addition, in fiscal 1998 two insurance events were recorded
that reduced expenses by $0.4 million. As a result of the dismissal of a
securities class action lawsuit in November 1997, we were reimbursed $0.2
million for costs incurred in connection with the lawsuit. Most of these
expenses were recorded in fiscal 1997. In addition, we received a $0.2 million
reimbursement of medical expenses due to a negotiated cost cap in a partially
self-funded insured health plan. Also as a result of our increased profitability
during fiscal 1999 over fiscal 1998, the profit sharing accrual (which was based
on 5% of operating income) has grown $0.4 million. We anticipate that total
sales, general and administrative costs will increase in connection with the
growth of our business; however, we believe that as a percentage of revenue they
will remain constant or possibly decline.
Other Expense
Other expense increased 107% to $1.1 million during fiscal 1999 from $0.5
million in fiscal 1998. During fiscal 1999, we realized impairments to leasehold
costs as a result of management's decision to move equipment from our leased
facility to our new manufacturing site. We also wrote-off other assets that had
no future value to the Company. These write-offs were slightly offset by income
recognized under our equipment build-out agreement with C3. In fiscal 1998 and
1999, we sold equipment manufactured by us to C3 at cost plus an overhead
allocation equivalent to that recognized on our government contracts. The
reimbursement by C3 of actual manufacturing costs was recorded as a reduction in
fixed assets, while the overhead allocation portion of the funds offset "Other
expense."
-24-
Interest Income, net
Interest income, net has increased 45% to $1.1 million in fiscal 1999 from $0.7
million in fiscal 1998 due to higher average cash balances being available in
fiscal 1999 as a result of a public stock offering completed in February 1999. A
portion of the proceeds received from the offering was used to repay all debt
that was outstanding; therefore during much of the third quarter and all of the
fourth quarter of fiscal 1999, there was no interest expense incurred. In
November 1997, we obtained a term loan from NationsBank to fund the acquisition
and construction of our manufacturing facility in Durham, North Carolina. Most
of that interest was capitalized during fiscal 1998.
Income Tax Expense
Income tax expense for fiscal 1999 was $4.9 million compared to $2.6 million in
fiscal 1998. This increase resulted from increased profitability during fiscal
1999 over fiscal 1998. Our effective tax rate during fiscal 1999 was 28%
compared to 29% in fiscal 1998.
FISCAL YEARS ENDED JUNE 28, 1998 AND JUNE 30, 1997
Revenue
Revenue increased 47% from $29.0 million in fiscal 1997 to $42.5 million in
fiscal 1998. A significant portion of the rise in product
revenue was directly attributable to the 132%
increase in blue light-emitting
diode ("LED")LED volume sold pursuant to an amendment to athe purchase agreement
signed in
September 1996 with Siemens A.G. ("Siemens"). ThatSiemens. This agreement and two subsequent amendments provided for $6.8 million
in additional sales to Siemensrevenue in fiscal 1998 over fiscal 1997. As amended, the agreement presently obligates Siemens to
purchase certain quantities of LED products through December 1998. Additionally,
the amendment provides for higher prices per unit on items shipped earlyThis significant increase
in the
contract, with unit prices being reduced as volume increasessold was offset by a 32% decline in the latter part
of the contract. Further reductions in per unit costs are expected throughout
fiscal 1999 as a result of the full implementation to the conductive buffer
product, higher throughput and other plant asset efficiencies. There can be no
assurance that these
18
efficiencies will be achieved. LED sales also increased by 70% in fiscal 1997
over 1996 amounts due to volume stemming from the original agreement and first
amendment with Siemens.
The Company continues to focus on obtaining additional LED customers
who are interested in ordering commercial quantities of the product. To meet
this goal the Company anticipates the release of new higher brightness blue and
green LED products, which are expected to be competitive in outdoor
applications, during the first half of fiscal 1999. Anticipated volume
associated with these new products, combined with lower LED pricing, are
expected to increase customer orders. If the Company is unable to expand its
customer base or release these new products, its revenue and earnings growth
potential could be adversely impacted. The Company believes that in order to
significantly grow market demand for LED products and to defray competition, it
must continue to substantially lower prices. During fiscal 1998, the Company'sour average sales price per LED
unit dropped 32% over 1997 levels. This decline in
price was more than offset by the 132% increase in product volume. The Company's
goal is to continue to lower sales prices to meet customer price points
throughout fiscal 1999. While the Company reported a lower average sales price
for LEDs during fiscal 1998, total product profitability increased due to higher
volumes and other efficiencies. Overall, average chip costs also declined in
fiscal 1998 due to a combination of a smaller chip size, the conversion to a two
inch diameter wafer, higher volume which spreads fixed costs over more units
and, in the latter half of the fourth quarter, benefits from the conductive
buffer technology.
During 1999, the Company anticipates further reductions in chip costs
due to the full year benefits of the conductive buffer process, higher volume
throughput and greater yield. If the Company is unable to realize these
benefits, profits are anticipated to deteriorate during fiscal 1999 due to
declining per unit sales prices in the Company's contract with Siemens. Greater
volume, while maintaining margins per unit, has been and will continue to be
Cree's strategy in the LED marketplace. Many current and potential customers
for the Company's products are based in Asia. Poor economic conditions and
currency devaluation in some countries may adversely affect the Company's
ability to increase sales volume both as a result of lower demand by customers
and competition reducing the price of products.sold.
Wafer and other materials revenue has increased 56%110% in fiscal 1998 over fiscal 1997
due primarily to a 29% increase in wafer volume associated with a greater interest in the
worldwide research community for SiC-based products. The Company
continues to make improvements to the quality of its SiC material, thus
increasing the demand for research in microwave and power applications. These
wafer quality improvements have also led to corporate research funding,
including work performed toward the development of both microwave and power
devices during the year. Profits contributed by wafer sales are expected to riseproducts, as the Company continues to improve quality while lowering costs due to higher
throughput and greater yield efficiency. During fiscal 1997, wafer saleswell as revenues from
C3. C3 activity grew
60% over 1996 amounts, due to the greater acceptance of the material in the
marketplace and a slight increase in the average sales price due to a greater
mix of premium wafer products available with low defect levels.
In July 1997, the Company announced development and supply agreements
with C3, to develop and supply bulk single crystal silicon carbide for gemstone
applications. The development program included the development of improved
processes for manufacturing colorless single crystalline SiC for use in
gemstones with diamond-like characteristics. This research is particularly
important as it also funds the development of larger diameter crystals. In
addition to the development agreement, the Company also entered into an
exclusive supply agreement where the output of dedicated production was supplied
and priced at cost plus a stipulated margin. For fiscal 1999, pricing under the
supply agreement has been superseded by a separate agreement that allows output
from dedicated production to be priced based on the quality of the material. In
addition, C3 has agreed to pay the Company up to $3.4 million for the purchase
of additional equipment to increase available capacity at Cree. Over one half of
this equipment was billed to C3 during fiscal 1998, however this transaction was
not recorded as revenue. Total revenue for materials used in gemstone
applications increased 89% in fiscal 1998 as compared to 1997 as a result of these two agreements. Material purchased
19
by C3 under the execution in July 1997 of the new supply
agreement may be used solelyand development agreement. Revenues for the fabrication and sale
of gemstones. During fiscal 1997 and 1996, the Company sold material products to
C3 at margins consistent with those achieved in connection with sales of similar
products to the Company's other customers.
Financial results for the display product line includes sales of both
modules and sign products. Revenue for the modulesdisplays business
increased by 29%37% in fiscal 1998 over the prior yearfiscal 1997 due to increased interest among
customers for theindoor video display indoor stadium sign. Moving message sign sales by RCD, the
Company's subsidiary, suffered a 72% decline in revenue compared to 1997 due to
a 71% decrease in volume and slightly reduced average sales prices. This
reduction was prompted by the Company's shift to the module product line. During
fiscal 1998, the Company primarily sold an existing inventory of moving message
signs and did not expand or refresh the product line. The Company is currently
reviewing the business plan of these product lines to maximize sales for fiscal
1999. The Company expects the release of low priced, high brightness LED
products that will compete in outdoor applications in fiscal 1999. These new
LEDs are anticipated to change market opportunities for display products.
Revenue for the display business grew 76% in fiscal 1997 from 1996 due to the
introduction of the modules line of business during that year.displays.
Contract Revenue
Research contract revenue increased 17% to $7,640,000$7.6 million during fiscal 1998 as compared to
fiscal 1997, as a result of a change in the mix of funding from available
contracts. FundingContracts funded for fiscal 1997 included a higher amount of proceeds
recognized under two cost-share arrangements. For these agreements,arrangements, funds are
recorded as a reduction in research and development expense rather than as
contract revenue. As funds associated with these two programs were exhausted
during the second quarter of
fiscal 1998, Companywe shifted our resources were shifted to programs under a cost-plus or
catalog price arrangement, in which funding is recorded as contract revenue.
Therefore contract revenue was higher in fiscal 1998 than 1997.
Contract
revenue grew 66% to $6,535,000 in fiscal 1997 as higher revenues were generated
as a result of more funding being made available from the U.S. government for
certain research contracts, primarily in the areas of microwave, power, blue
laser and basic material development.
License Fee Income
Included in revenue for fiscal 1997 is a one-time license fee of $2,615,000.$2.6 million.
This license fee was earned pursuant to a License and Technology Transfer
Agreement entered into in September 1996 with Shin-Etsu Handotai Co.
Ltd. ("Shin-Etsu").Shin-Etsu. Pursuant to this
agreement, the Companywe granted Shin-Etsu a license to use certain epitaxial and device
fabrication process technology for the manufacture of the Company'sour blue LED product. The Company also recorded an
accrued expense of $186,000 payable in July 1998 to a third party that brokered
the agreement. Results for fiscal 1996 include a one-time netWe
did not record any license fee revenue of $1,423,000. This license fee was earned pursuant to a Development
License and Supply Agreement entered in October 1995 with Siemens, in which the
Company granted Siemens a license to use certain technology to manufacture blue
and green LED products. No license fee arrangements were recorded by the Company
during fiscal 1998.
Cost of Revenue
The Company's-25-
Gross Profit
Our gross marginprofit increased 47% to $14,552,000, or 34% of
revenue for$14.6 million in fiscal 1998. The Company's1998 over fiscal 1997.
Our gross margin as a percentage of sales was 34% for both fiscal 1998 and 24% in 1997 and 1996, respectively.fiscal 1997. License fee revenue,fees,
which hashave no corresponding cost, iswere included in bothfiscal 1997 and 1996 results. Without
license fees,fee revenue, gross marginsprofit would have been $7,263,000$7.3 million or 28% of revenue
for fiscal 1997
and $2,145,000 or 16% of revenue for the comparative period in 1996.1997. The overall increase in margingross profit in fiscal 1998 stemsresulted
from higher revenue and lower LED and materialsmaterial costs per unit. The lower unitLED and
wafer costs were recognized due to higher 20
throughput, which more effectively
utilized plant capacity and yield efficiencies on LED and wafer products. Thisefficiencies. The greater throughput enabled the
Companyus to
spread fixed cost investments over a larger volume of product. Greater yield in
LED applications resulted from a combination of a new smaller die size theand a new
two inchlarger two-inch diameter wafer and in the fourth quarter of fiscal 1998, the
introduction of the conductive buffer technology. Yield was also higher for LED
and materials due to plant processing efficiency and improvements and a higher quality of wafer
materials.
Higher marginsmaterials used in the future are largely contingent on the Company's ability to
increase the volume of LEDs produced, by gaining a larger customer base,
successfully introducing new products and continued savings from the conductive
buffer technology. These factors are significant due to the anticipated decline
in the average LED per unit sales price to be received in 1999. If the Company
is unable to improve efficiency under the new chip standards or gain orders for
additional volume, gross margin could be negatively impacted. Gross margin
improved in 1997 from 1996 levels, due to higher revenue and throughput
associated with the Siemens agreement, and yield efficiencies, which lowered the
manufacturingthese products.
The cost per unit.
The Company benefits from research and development efforts sponsored by
U.S. government contracts. Contracts are awarded to the Company to fund both
short-term and long-term research projects. For contracts under which the
Company anticipates that funding will exceed direct costs, all funding is
reported as contract revenue and direct costs are reported as cost of contract
revenue. For contracts under which the Company anticipates that direct costs
will exceed funding, costs are reflected as research and development expenses
with the related funding amounts offsetting these costs. Cost of contract revenue has increased in fiscal 1998 over fiscal 1997, due
primarily to the exhaustionchange in the mix of fundsfunding from available contracts. Costs for fiscal
1997 included a higher amount of expenses recognized under two cost-share
contracts during the first half of the
year. Costs for research underarrangements. For these two arrangements, were includedcosts are recorded as research and
development expenses rather than a cost of contract revenue. When funding under
these two contracts was completed in the second quarter of fiscal 1998, all
resources were shifted to cost-plus and catalog priced contracts, where expenses
are recorded as a cost of contract revenue.
Contract cost of revenue
was significantly higher in fiscal 1997 than 1996 as a result of more funding
being made available from the U.S. government for certain research contracts,
primarily in the areas of microwave, power, blue laserResearch and basic material
development.Development
Research and development costs have decreased by 3% to $1,774,000approximately $1.8 million in
fiscal 1998 from approximately $1.8 million in fiscal 1997 due to a reduction in
work performed under two cost-share contracts to further the blue laser
research. Net costs to the Company for these projects
were $276,000 and $671,000 for fiscal 1998 and 1997, respectively. These cost-share contracts concluded during the first half of fiscal
1998. Additionally, research and development costs for fiscal 1997 included a
one-time write offwrite-off of $93,000$0.1 million for the closure of the Company's Eastern European Division. Theour Eastern European
Division, located in St. Petersburg, Russia, was a research group
performing some of the Company's basic materialRussia.
Sales, General and device development work.
Work performed under cost-share arrangements in fiscal 1997 also explains
why research and development costs were higher in that year than in 1996.Administrative Expenses
Sales, and general and administrative expenses decreased 4% to $4,131,100$4.1 million for
fiscal 1998 comparedfrom $4.3 million in fiscal 1997 due to 1997 levels as increased costs to
support the growthreceipt of the business were offset by two one-time
insurance payments to the Company.payments. As a result of the dismissal in November 1997 of a
securities class action lawsuit filed in October 1996, the Company waswe were reimbursed $216,000 by its$0.2
million from our insurance carrier for costs incurred in defense of the suit. In
addition, as a result of a negotiated cost cap, the Companywe received a $220,000$0.2 million
reimbursement of medical expenses that were incurred under a partially
selfself-funded insured health plan. As a percentage of revenue, these costs have
decreased to 10% in fiscal 1998 from 15% and 19% in 1997 and 1996, respectively. Total
sales and general and administrative expenses increased 47% in fiscal 1997 over
1996 amounts due to higher costs associated with additional sales personnel to
focus the business on gaining new LED customers, the SEH license agreement
commission fee (a net present value of $172,000) and greater legal fees in
connection with the defense of a securities class action lawsuit that has since
been dismissed. The Company anticipates that sales and general and
administrative1997.
Other Expense
In fiscal 1998, other expenses will continue to rise in future
21
periods to support the anticipated growth of the business, however, the cost as
a percentage of total revenue is expected to decline as economies of scale
continue to be realized.
Other (income) expense includesincluded a net loss recorded on the write-down of
leasehold improvements, the disposal of certain other fixed assets and thea
write-off of $66,000 for the remaining value of goodwill associated with the
acquisition of the Real Color Displays subsidiary. In addition, the Company haswe entered into
an agreement with C3 to sell equipment manufactured by the Companyus at cost plus a
reasonable overhead allocation. The overhead allocation was recorded as "other operating income";"Other
income;" however, the amount was more than offset by leasehold write-offs
associated with the move to theour new facility and other asset disposals. Net interestOther
expense for fiscal 1997 was higher than that recorded in fiscal 1998 as large
fixed asset write-downs
-26-
were recorded as the result of a physical plant inventory. These write-downs
were greater than those recorded in fiscal 1998.
Interest Income, net
Interest income, net increased by $123,000$0.1 million in fiscal 1998 over fiscal 1997 results and
decreased by $260,000 when comparing 1997 to 1996,
due to higher investable cash balances available in fiscal 1998 and 1996.1998. Cash balances
were highhigher in fiscal 1998 as the Companywe generated over $12approximately $12.1 million from
operations compared to $6approximately $6.1 million in fiscal 1997.
Also, the Company concluded a private equity placement
in September 1995 that also increased available cash in 1996.
The Company'sIncome Tax Expense
Our effective income tax provision hasrate increased to 29% for fiscal 1998 from a 5%
effective rate experienced during fiscal 1997. The lower rate for fiscal 1997 resulted from
the utilization of net operating loss carryforwards.
LIQUIDITY AND CAPITAL RESOURCES
We have funded our operations to date through sales of equity, bank borrowings
and revenue from product and contract sales. On February 17, 1999, we completed
our public stock offering and raised approximately $45.3 million, net of
offering expenses and the repayment of long-term debt. There were no selling
shareholders. The Company expects that the majority of these funds will continue
to be used to expand facilities and equipment capacity. The remainder will be
used for general corporate purposes, including working capital and potential
acquisitions of or investments in complementary businesses. The Company may also
issue additional shares of common stock for the acquisition of complementary
businesses or other significant assets. Although the Company from time to time
evaluates potential acquisitions of and investments in businesses and
anticipates continuing to make such evaluations, the Company has no present
commitments or agreements with respect to the acquisition or investment in
another business. As of June 27, 1999, we had working capital of approximately
$60.2 million, including $48.7 million in cash and cash equivalents and
marketable securities.
Operating activities generated $19.9 million in cash during fiscal 1999. This
was attributable primarily to net income of $12.7 million, other non-cash
expenses of $7.2 million, $3.5 million in deferred income tax benefits and $2.7
million for tax benefits associated with stock options. These amounts were
partly offset by an increase of $6.2 million in accounts receivable and a slightly higher tax rate for$1.4
million rise in inventory.
Most of the $45.3 million of cash used in investing activities in fiscal 1999
as most carryforwards previously
available have now been utilized.was related to expenditures associated with the construction of our new
manufacturing facility in Durham, North Carolina and increased manufacturing
capacity in the crystal growth, epitaxial, clean room and pack and test areas.
The Company had no tax provisionalso invested $4.5 million to acquire an investment in 1996 as
the Company generated a net operating loss for tax purposes.
Liquidity and Capital Resources
Netcommon
stock of MVIS.
The $50.1 million of cash provided by operations reached a record $12,092,000financing activities in 1998
compared with $6,097,000 in 1997, and cash used in operations of $1,636,000 in
1995. These increases reported in 1998 and 1997 resulted from profitable
operations of the Company. If the Company achieves its goals of increasing
customer demand while lowering production costs, the Company expects that cash
provided by operations will increase infiscal 1999
and will be sufficient to fund all
anticipated capital additions. The Company will; however, consider opportunities
to raise capital and to fund development costs through strategic alliances and
other manners.
The number of trade average days sales outstanding was reduced to 50
for 1998 from 57 and 96 days experienced in 1997 and 1996, respectively, due to
collections efforts during the year.
The Company invested $15,287,000 in capital equipment during 1998
compared to $8,115,000 and $14,740,000 spent during 1997 and 1996, respectively.
The majority of the 1998 spending, or $11,400,000, was duerelated primarily to the acquisitionreceipt of $61.4 million related to proceeds from the
public stock offering and upfitthe exercise of stock warrants and stock options from
the Company's employee stock option plan. This significant inflow of cash was
partly offset by the $10.0 million payoff of long term debt and a $3.2 million
repurchase of common stock. This stock was repurchased at an average price of
$6.84 per share. The stock warrants exercised were distributed in connection
with our September 1995 private placement and have an exercise price of $13.62.
As of June 27, 1999 warrants remained outstanding to purchase 258,000 shares;
these warrants will expire in September 2000.
-27-
We are currently engaged in construction activities related to a new production facility near Research Triangle Park, North
Carolina. The total capital outlay for this facilitypackaging
area and associated upfit is
estimated to be approximately $15,000,000 and isthe expansion of our crystal growth department. These additions, which
are expected to be completed over
the next six months. The Company currently hasby calendar year end, will allow us to consolidate
all LED and wafer manufacturing facilities to one site with improved
manufacturing capabilities. In order to grow existing products and provide
expanded facilities for our new microwave product line, we anticipate a loan commitmentsecond
phase of upexpansion to $10,000,000 from a commercial bankfacilities and infrastructure to finance a portion ofbegin in fiscal 2000. We
anticipate total costs for these expenditures.
As of June 28, 1998, approximately $8,667,000 had been drawn against this loan.
At this time, the Company anticipates capital additions in 1999expenses to be 25% lower
than amounts spent in 1998between $15 and intends$20 million.
Estimates for equipment costs related to this expansion also total between $15
and $20 million. We plan to fund these additionscapital projects with internally
generated cash provided by operations andplus cash on hand.
In addition,IMPACT OF THE YEAR 2000
State of Readiness
We have evaluated all of our internal software, embedded systems and products
against Year 2000 concerns and believe that our products and businesses will not
be substantially affected by the Company also expects
to draw the remaining $1,333,000 on the loan commitment and may consider other
financing alternatives. During 1997, investments were made for equipment
additions in the crystal growth and epitaxial departments. During 1996, a
significant investment was made for equipment related to the production of LED
and wafer products. Financing activities provided the Company $10,341,000 during
1998 mostly due to the proceeds from the issuance of long term debt discussed
above. In addition, financing activities yielded $20,924,000 during fiscal 1996.
The majorityadvent of the funding was provided by the September 1995 private placement
which netted approximately $17.5 million.
22
Year 2000
The Company's products are ofyear 2000. We have completed a nature that they are not subject to
failure because of Year 2000 issues. The Company however, has assigned full-time
information technology professionals to the task of identifying and resolving
Year 2000 problems that may affect the Company's business, and has adopted a
phased
Year 2000 compliance plan. Duringplan that included four phases: inventory, assessment,
remediation and testing. A detailed inventory of all computers and related
systems was completed and all critical upgrades were finished for all computers
that were non-Year 2000 compliant. All factory-dependent computers were also
tested and are now Year 2000 compliant. The only other remaining steps include a
network patch that impacts our utilities and the first phase, commenced in April
1998conversion of the electronic
mail system. We do not believe that these conversions are business critical.
Individual software installations are also being reviewed. These remaining areas
should be completed no later than September 1999.
Although we cannot control whether and targeted for completion in December 1998,how third parties will address the Company will inventory
and collect documentation on all of its computers, computer related equipment,
and equipment with embedded processors. In addition, the Company will contactYear
2000 issue, we have now contacted critical vendors and suppliers to obtain assurances of theirand have been
informed that they have the ability to ensure smooth delivery of products
and services after December 1999. In the second and
third phases, the Company will prioritize and implement necessary repairs or
replacements to equipment in order to achieve Year 2000 compliance, which it
expects to complete in the first quarter of 1999. The final phase will consist
of a testing program, scheduled for completion in the second quarter of 1999.
The Company has not prepared estimates of costs for correction ofwithout disruptions caused by Year 2000 problems. Based on information available at this time, including the responses of
these vendors to our survey, we believe that our vendors are either
substantially Year 2000 compliance statuscompliant or that any noncompliance will not have a
material effect on our operations. We have now received assurances from 95% of
equipmentthese vendors. We anticipate that has been examined as well as the anticipated
replacement schedule for equipment, the Company doesremaining vendors also will be able to
ensure delivery of product; however, we do not expect that this assessment will
be complete until September 1999.
Costs
We do not believe that the cost
of remedial actions willcosts associated with Year 2000 compliance have had a
material adverse effect on the Company'sour business, results of operations or financial
condition. As of June 27, 1999, this project is substantially complete and we do
not anticipate that we will incur any material costs in winding up the project.
Year 2000 Risks
Although we believe that our planning efforts are adequate to address our Year
2000 concerns, there can be no assurance that we will not experience negative
consequences and material costs as a result of undetected errors or defects in
the technology used in our internal systems. Also, there is no assurance that
the systems of third parties on which we rely will be made compliant on a timely
basis. If realized, these risks could result in an adverse effect on our
business, results of operations and financial condition.
-28-
We believe that our greatest risk stems from the potential non-compliance of our
suppliers. We depend on a limited number of suppliers for certain raw materials,
components and equipment necessary for the manufacture of our products.
Accordingly, if those suppliers are unable to process or fill our orders or
otherwise interact with us because of Year 2000 problems, we could experience
material adverse effects to our business. We are in the process of assessing the
Year 2000 status of our suppliers and are investigating alternate sources of
supply. As a consequence of our dependence on limited sources of supply, we
generally maintain a significant inventory of certain critical materials and
require suppliers to keep certain amounts of inventory available for us. There
can be no assurance however, that therewe will have enough materials on hand to continue
production without interruption in the event one or more of our suppliers
experiences Year 2000 problems that affect its (their) ability to supply us. Any
supply chain disruptions would affect our ability to manufacture our products,
which could result in material adverse consequences to our business, results of
operations and financial condition.
Contingencies
We have not beyet developed a delay in, or increased costs associated with,contingency plan to address what the implementation of corrections asCompany should
do if we are unable to address the Year 2000 complianceissue. We expect the contingency
plan to be in place after the inquiry of vendors and customers is performed.
Failurecompleted.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Quantitative Disclosures:
As of June 27, 1999, the Company maintains an investment in equity securities
that is treated for accounting purposes under SFAS 115 as "available for sale"
securities. This investment is carried at fair market value based upon quoted
market price of that investment as of June 27, 1999, with net unrealized gains
or losses excluded from earnings and reported as a separate component of
stockholder's equity. This investment, which consists of common stock of MVIS,
is subject to implementmarket risk of equity price changes. The common stock of MVIS is
publicly traded on the Nasdaq National Market. The Company acquired these shares
from MVIS in a private placement and has agreed not to sell the shares until at
least January 6, 2000; however, MVIS filed a registration statement in August
1999 covering the Company's sale of these shares. Since the Company is currently
restricted from trading these shares and management views this transaction as an
investment, the shares are accounted for as "available for sale" securities
under SFAS 115. The fair market value of this investment as of June 27, 1999,
using the closing sale price as of June 25, 1999, was $6.1 million, representing
268,600 shares.
During fiscal 1999, the Company repaid the term loan that was outstanding as of
June 28, 1998. The Company currently has no debt outstanding, therefore, Cree is
no longer subject to interest rate risk.
Qualitative Disclosures:
The investment in MVIS common stock is subject to the market risk of equity
price changes. While the Company can not predict or manage the future market
price for such changes could havestock, management continues to evaluate its investment position
on an adverse effect on future results
of operations. In addition, unexpected costs of correcting equipment that has
not yet been fully evaluated could have an adverse effect on future results of
operations.
23ongoing basis.
-29-
Item 8. Financial Statements and Supplementary Data
Index to Consolidated Financial Statements
Page
----
Report of Independent Accountants 25Auditors..............................................31
Report of Independent Accountants...........................................32
Consolidated Balance Sheets as of June 28, 199827, 1999 and June 30, 1997 2628, 1998...........33
Consolidated Statements of Operations for the years ended June 28, 1998, and June 30, 1997 and 1996 27, Consolidated Statements of Cash Flows for the years ended1999,
June 28, 1998 and June 30, 19971997.............................................34
Consolidated Statements of Cash Flow for the years ended June 27, 1999,
June 28, 1998 and 1996 28June 30, 1997.............................................35
Consolidated Statements of Shareholders' Equity for the years ended
June 27, 1999, June 28, 1998 and June 30, 1997 and 1996 301997..............................36
Notes to Consolidated Financial Statements 31
24Statements..................................37
-30-
REPORT OF INDEPENDENT ACCOUNTANTSAUDITORS
Board of Directors and Shareholders
Cree Research, Inc.
We have audited the accompanying consolidated balance sheet of Cree Research,
Inc. and subsidiaries as of June 27, 1999, and the related consolidated
statements of income, shareholders' equity, and cash flows for the year then
ended. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audit. The consolidated financial statements of Cree
Research, Inc. and subsidiaries as of and for the two year period ended June 28,
1998 were audited by other auditors whose report dated July 22, 1998 expressed
an unqualified opinion on those statements.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of Cree
Research, Inc. and subsidiaries as of June 27, 1999, and the consolidated
results of their operations and their cash flows for the year then ended, in
accordance with generally accepted accounting principles.
Ernst & Young LLP
Raleigh, North Carolina
July 23, 1999
-31-
REPORT OF INDEPENDENT ACCOUNTANTS
Board of Directors and Shareholders
Cree Research, Inc.
In our opinion, the accompanying consolidated balance sheetssheet and the related
consolidated statements of operations, of shareholders' equity, and of cash
flows and shareholders' equity, present fairly, in all material respects, the financial position of Cree
Research, Inc. and subsidiaries at June 28, 1998, and June 30, 1997, and the results of their
operations and their cash flows for the yearyears ended June 28, 1998 and for the two years in the period ended June 30,
1997, in conformity with generally accepted accounting principles. These
financial statements are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits of these statements in accordance with
generally accepted auditing standards which require that we plan and perform the
audit to obtain reasonable assurance about whether the financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for the opinion expressed
above.
PricewaterhouseCoopers LLP
Raleigh, North Carolina
25July 22, 1998
-32-
CREE RESEARCH, INC.
CONSOLIDATED BALANCE SHEETS
(in 000's,(In thousands, except per share amounts)
June 28, June 30,
1998 1997
-------- --------
ASSETS
Current assets:
Cash and cash equivalents $ 17,680 $ 10,448
Marketable securities 657 --
Accounts receivable, net 10,479 7,694
Inventories 2,543 3,949
Deferred income tax 1,952 1,830
Prepaid expenses and other current assets 1,347 466
-------- --------
Total current assets 34,658 24,387
Property and equipment, net 36,476 24,333
Patent and license rights, net 1,525 1,267
Other assets 65 150
-------- --------
Total assets $ 72,724 $ 50,137
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable, trade $ 5,595 $ 2,248
Current maturities of long term debt 17 --
Accrued salaries and wages 391 292
Other accrued expenses 1,052 834
-------- --------
Total current liabilities 7,055 3,374
Long term liabilities:
Long term debt 8,650 --
Deferred income tax 2,154 1,638
-------- --------
Total long term liabilities 10,804 1,638
Shareholders' equity:
Preferred stock, par value $0.01; 2,750 shares authorized;
none issued and outstanding -- --
Common stock, $0.005 par value; 14,500 shares authorized;
shares issued and outstanding 12,989 at June 28, 1998
and 12,523 at June 30, 1997 65 62
Additional paid-in-capital 49,676 46,214
Retained earnings (deficit) 5,124 (1,151)
-------- --------
Total shareholders' equity 54,865 45,125
-------- --------
Total liabilities and shareholders' equity $ 72,724 $ 50,137
======== ========
June 27, June 28,
1999 1998
--------- ---------
ASSETS
Current assets:
Cash and cash equivalents $ 42,506 $ 17,680
Marketable securities 6,145 657
Accounts receivable, net 16,285 10,479
Inventories 3,977 2,543
Deferred income taxes 296 1,952
Prepaid expenses and other current assets 558 1,347
--------- ---------
Total current assets 69,767 34,658
Property and equipment, net 69,884 36,476
Patent and license rights, net 1,731 1,525
Deferred income taxes 2,827 --
Other assets 8 65
--------- ---------
Total assets $144,217 $ 72,724
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable, trade $ 7,487 $ 5,595
Current maturities of long term debt -- 17
Accrued salaries and wages 819 391
Other accrued expenses 1,239 1,052
--------- ---------
Total current liabilities 9,545 7,055
Long term liabilities:
Long term debt -- 8,650
Deferred income taxes 4,650 2,154
--------- ---------
Total long term liabilities 4,650 10,804
Shareholders' equity:
Preferred stock, par value $0.01; 3,000 shares -- --
authorized at June 27, 1999 and 2,750 shares
authorized at June 28, 1998; none issued and
outstanding
Common stock, par value $0.0025; 60,000 shares 73 65
authorized at June 27, 1999 and 29,000 shares
authorized at June 28, 1998; shares issued and
outstanding 29,258 and 25,978 at June 27, 1999
and June 28, 1998, respectively
Additional paid-in-capital 111,136 49,676
Retained earnings 18,813 5,124
--------- ---------
Total shareholders' equity 130,022 54,865
--------- ---------
Total liabilities and shareholders' equity $144,217 $ 72,724
========= =========
The accompanying notes are an integral part of the
consolidated financial statements.
26-33-
CREE RESEARCH, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in 000's(In thousands, except per share amounts)
June 28, June 30, June 30,
1998 1997 1996
-------- -------- --------
Revenue:
Product revenue, net $ 34,891 $ 19,823 $ 9,689
Contract revenue, net 7,640 6,535 3,945
License fee income -- 2,615 1,423
-------- -------- --------
Total revenue 42,531 28,973 15,057
Cost of revenue:
Product revenue, net 21,727 13,388 8,411
Contract revenue, net 6,252 5,707 3,078
-------- -------- --------
Total cost of revenue 27,979 19,095 11,489
Gross margin 14,552 9,878 3,568
Operating expenses:
Research and development 1,774 1,826 1,286
Sales, general and administrative 4,131 4,301 2,917
Other (income) expense 502 639 (11)
-------- -------- --------
Income (loss) from operations 8,145 3,112 (624)
Interest income, net 730 607 867
-------- -------- --------
Income before income taxes 8,875 3,719 243
Income tax expense 2,600 177 --
-------- -------- --------
Net income $ 6,275 $ 3,542 $ 243June 27, June 28, June 30,
1999 1998 1997
--------- -------- --------
Revenue:
Product revenue, net $ 53,464 $34,891 $19,823
Contract revenue, net 6,586 7,640 6,535
License fee income -- -- 2,615
--------- -------- --------
Total revenue 60,050 42,531 28,973
Cost of revenue:
Product revenue, net 26,977 21,727 13,388
Contract revenue, net 4,943 6,252 5,707
--------- -------- --------
Total cost of revenue 31,920 27,979 19,095
Gross profit 28,130 14,552 9,878
Operating expenses:
Research and development 4,443 1,774 1,826
Sales, general and administrative 6,064 4,131 4,301
Other expense 1,041 502 639
--------- -------- --------
Income from operations 16,582 8,145 3,112
Interest income, net 1,060 730 607
--------- -------- --------
Income before income taxes 17,642 8,875 3,719
Income tax expense 4,940 2,600 177
--------- -------- --------
Net income $12,702 $ 6,275 $ 3,542
========= ======== ========
Other comprehensive income, net of tax
Unrealized holding gains 987 -- --
========= ======== ========
Comprehensive income $13,689 $ 6,275 $ 3,542
========= ======== ========
Earnings per share:
Basic $0.47 $0.24 $0.14
========= ======== ========
Diluted $0.45 $0.23 $0.13
========= ======== ========
Shares used in per share calculation:
Basic 27,015 25,726 24,911
========= ======== ========
Diluted 28,432 26,987 26,251
========= ======== ======== ========
Basic earnings per common share $ 0.49 $ 0.28 $ 0.02
======== ======== ========
Diluted earnings per common share $ 0.47 $ 0.27 $ 0.02
======== ======== ========
Weighted Average Shares Outstanding 13,493 13,126 12,615
======== ======== ========
The accompanying notes are an integral part of the
consolidated financial statements.
27-34-
CREE RESEARCH, INC.
CONSOLIDATED STATEMENTS OF CASH FLOW
(in 000's)
June 28, June 30, June 30,
1998 1997 1996
-------- -------- --------
Operating activities:
Net income $ 6,275 $ 3,542 $ 243
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 4,217 3,356 1,765
Loss (gain) on disposal of property & equipment 719 631 (8)
Loss on write off of patents 17 141 --
Amortization of patent rights 102 108 126
Amortization & write off of goodwill 86 41 41
Purchase of marketable trading securities (1,500) -- --
Proceeds from sale of marketable trading securities 421 -- --
Loss on marketable trading securities 32 -- --
Deferred income taxes 394 (192) --
Tax benefits associated with stock options 1,791 96 --
Changes in assets & liabilities:
Accounts receivable (2,398) (891) (3,258)
Inventories 1,406 (723) (1,549)
Deferred cost on research contracts -- -- 81
Prepaid expenses & other assets (882) (262) 49
Accounts payable, trade 1,092 (226) 714
Accrued expenses 320 476 160
-------- -------- --------
Net cash provided by (used in) operating activities 12,092 6,097 (1,636)
-------- -------- --------
Investing activities:
Maturity of investment securities -- 1,787 2,124
Purchase of property & equipment (15,287) (8,115) (14,740)
Proceeds from sale of assets 463 13 52
Purchase of patent rights (377) (310) (310)
-------- -------- --------
Net cash used in investing activities (15,201) (6,625) (12,874)
-------- -------- --------
Financing activities:
Proceeds from issuance of long-term debt 8,667 -- --
Net proceeds from issuance of common stock 2,936 926 20,924
Repurchase of common stock (1,262) (112) --
-------- -------- --------
Net cash provided by financing activities 10,341 814 20,924
-------- -------- --------
Net increase in cash and cash equivalents $ 7,232 $ 286 $ 6,414
Cash and cash equivalents:
Beginning of year 10,448 10,162 3,748
-------- -------- --------
End of year $ 17,680 $ 10,448 $ 10,162(In Thousands)
June 27, June 28, June 30,
1999 1998 1997
-------- -------- --------
Operating activities:
Net income $ 12,702 $ 6,275 $ 3,542
Adjustments to reconcile net income
to net cash provided by operating
activities:
Depreciation and amortization 5,382 4,217 3,356
Loss on disposal of property and
equipment 1,602 719 631
Loss on write off of patents 51 17 141
Amortization of patent rights 117 102 108
Amortization and write off of goodwill -- 86 41
Purchase of marketable trading
securities (233) (1,500) --
Proceeds from sale of marketable
trading securities 1,421 421 --
Loss (gain) on marketable trading
securities (141) 32 --
Deferred income taxes 3,494 394 (192)
Income tax benefits from stock
option exercises 2,672 1,791 96
Changes in operating assets and liabilities:
Accounts receivable (6,196) (2,398) (891)
Inventories (1,434) 1,406 (723)
Prepaid expenses and other assets (1,981) (882) (262)
Accounts payable, trade 1,892 1,092 (226)
Accrued expenses 598 320 476
-------- -------- --------
Net cash provided by operating activities 19,946 12,092 6,097
-------- -------- --------
Investing activities:
Maturity of investment securities -- -- 1,787
Purchase of available for sale
security (4,500) -- --
Purchase of property and equipment (40,578) (15,287) (8,115)
Proceeds from sale of property and
equipment 186 463 13
Purchase of patent rights (374) (377) (310)
-------- -------- --------
Net cash used in investing
activities (45,266) (15,201) (6,625)
-------- -------- --------
Financing activities:
Net proceeds from issuance of long
term debt 1,350 8,667 --
Net repayment of long term debt (10,000) -- --
Net proceeds from issuance of common
stock 61,415 2,936 926
Receipt of Section 16(b) common
stock profits 594 -- --
Repurchase of common stock (3,213) (1,262) (112)
-------- -------- --------
Net cash provided by financing
activities 50,146 10,341 814
-------- -------- --------
Net increase in cash and cash equivalents $ 24,826 $ 7,232 $ 286
Cash and cash equivalents:
Beginning of year $ 17,680 $ 10,448 $10,162
-------- -------- --------
End of year $ 42,506 $ 17,680 $10,448
======== ======== ========
Supplemental disclosure of cash flow
information:
Cash paid for interest, net of
amounts capitalized $ 257 $ 74 $ --
-------- -------- --------
Cash paid for income taxes $ 2,175 $ 336 $ 300
======== ======== ========
The accompanying notes are an integral part of the
consolidated financial statements.
28-35-
CREE RESEARCH, INC.
CONSOLIDATED STATEMENTSSTATEMENT OF CASH FLOW
(in 000's)
(Continued)
Years Ended
-------------------------------------
June 28, June 30, June 30,
1998 1997 1996
-------------------------------------
Supplemental disclosure of cash flow information:
Cash paid for interest, net of amounts capitalized $ 74 $ - $ 5
=====================================
Cash paid for income taxes $ 336 $ 300 $ -
=====================================
SHAREHOLDERS' EQUITY
YEARS ENDING JUNE 27, 1999, JUNE 28, 1998 AND JUNE 30, 1997
(In Thousands)
Total
Common Additional Share-
Stock Paid-in Retained Treasury holders'
Par Value Capital Earnings Stock Equity
--------- ---------- --------- --------- --------
Balance at June 30, 1996 $ 61 $45,342 $(4,693) $ (38) $ 40,672
Common stock options
exercised for cash, 104
shares................... 160 160
Common stock warrants
exercised for cash, 406
shares................... 1 766 767
Purchase of common stock
for the treasury, 20 shares (112) (112)
Retirement of 40 treasury
shares................... (150) 150 --
Income tax benefits from
stock option exercises... 96 96
Net income............... 3,542 3,542
--------- ---------- --------- --------- --------
Balance at June 30, 1997 62 46,214 (1,151) -- 45,125
Common stock options
exercised for cash, 434
shares................... 1 1,693 1,694
Common stock warrants
exercised for cash, 662
shares.................. 2 1,240 1,242
Purchase of common stock
for the treasury, 164 shares (1,262) (1,262)
Retirement of 164 treasury
shares.................. (1,262) 1,262 --
Income tax benefits from
stock option exercises... 1,791 1,791
Net income............... 6,275 6,275
--------- ---------- --------- --------- --------
Balance at June 28, 1998 65 49,676 5,124 -- 54,865
Common stock options
exercised for cash, 418
shares.................. 1 1,511 1,512
Common stock warrants
exercised for cash, 342
shares.................. 4,656 4,656
Issuance of common stock
for cash 2,990 shares... 7 55,240 55,247
Purchase of common stock
for the treasury, 2,990
shares................. (3,213) (3,213)
Retirement of 470 treasury
shares................. (3,213) 3,213 --
Receipt of Section 16(b)
common stock profits from a
director............... 594 594
Income tax benefits from
stock option exercises.... 2,672 2,672
Other comprehensive income,
net of tax............... 987 987
Net income............... 12,702 12,702
--------- ---------- --------- --------- --------
Balance at June 27, 1999 $ 73 $111,136 $ 18,813 $ -- $130,022
========= ========== ========= ========= =========
The accompanying notes are an integral part of the
consolidated financial statements.
29
CREE RESEARCH, INC.
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
YEARS ENDING JUNE 28, 1998 AND JUNE 30, 1997 AND 1996
(IN 000'S)
Common Additional Total
Stock Paid-in Retained Unearned Treasury Shareholders'
Par Value Capital Earnings Compensation Stock Equity
--------- ------- -------- ------------ -------- -------------
Balance at June 30, 1995 $ 52 $ 24,427 $ (4,936) $ (2) $ (38) $ 19,503
Common stock options exercised
for cash, 122 shares 1 412 413
Common stock warrants exercised
for cash, 665 shares 3 2,916 2,919
Compensation expense for
common stock options 2 2
Proceeds from sale of 1,079
shares of common stock and
300 common stock warrants,
net of issuance costs of $625 5 17,587 17,592
Net income 243 243
-------- -------- -------- -------- -------- --------
Balance at June 30, 1996 61 45,342 (4,693) -- (38) 40,672
Common stock options exercised
for cash, 52 shares 160 160
Common stock warrants exercised
for cash, 203 shares 1 766 767
Purchase of common stock for the
treasury, 10 shares (112) (112)
Retirement of 20 treasury shares (150) 150 --
Income tax benefits from stock
option exercises 96 96
Net income 3,542 3,542
-------- -------- -------- -------- -------- --------
Balance at June 30, 1997 62 46,214 (1,151) -- -- 45,125
Common stock options exercised
for cash, 217 shares 1 1,693 1,694
Common stock warrants exercised
for cash, 331 shares 2 1,240 1,242
Purchase of common stock for the
treasury, 82 shares (1,262) (1,262)
Retirement of 82 treasury shares (1,262) 1,262 --
Income tax benefits from stock
option exercises 1,791 1,791
Net income 6,275 6,275
-------- -------- -------- -------- -------- --------
Balance at June 28, 1998 $ 65 $ 49,676 $ 5,124 $ -- $ -- $ 54,865
======== ======== ======== ======== ======== ========
The accompanying notes are an integral part of the consolidated financial
statements.
30-36-
CREE RESEARCH, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. NATURE OF BUSINESS
Cree Research, Inc. (", the Company""Company," or "Cree"),"Cree," a North Carolina corporation,
develops, manufactures, and markets silicon carbide-based semiconductor devices.
Revenues are primarily derived from the sale of blue light emitting diodes, ("LEDs"),and
silicon carbide ("SiC") based materials and
full-color LED based electronic displays and modules.materials. The Company markets its blue LED chip products
principally to customers who incorporate them into packaged lamps for resale to
original equipment manufacturers. The Company also sells SiC material products
to corporate, government, and university research laboratories. In addition, the
Company is engaged in a variety of research programs related to the advancement
of SiC process technology and the development of electronic devices that take
advantage of SiC's unique physical and electronic properties. These research projects are primarily funded by
Federal government agencies and departments. The Company
recovers the costs of a majoritysignificant portion of its research and development
efforts from revenues on these contracts with agencies of the Federal
government. This funding is recorded as contract revenue.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The consolidated financial statements include the accounts of Cree Research,
Inc., and its wholly-owned subsidiaries, Real Color Displays, Inc. ("RCD"), Cree
Research FSC, Inc. ("FSC"), and Cree Technologies, Inc. ("Tech"). All material
intercompany accounts and transactions have been eliminated in consolidation.
Change in Fiscal Year
On September 24, 1997,The Company's fiscal year is a 52 or 53 week period ending on the Boardlast Sunday in
the month of Directors of Cree Research, Inc.June. In fiscal 1998, the Company changed the Company'sits fiscal year from the
twelve months ending June 30, to a 52
or 53 week yearthe 52-week period ending on the last Sunday in
the month of June. Accordingly, all
quarterly reporting reflected a 13 week period in fiscal 1998, except that the
period ended September 28, 1997, which commenced July 1, 1997, reflected the
results of twelve weeks and five days. The Company's 1998 fiscal year extended
for the period from July 1, 1997 to June 28, 1998.
Estimates
The preparation of these financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities, and the
disclosure of contingent assets and liabilities, at June 28, 199827, 1999 and June 30, 1997,28,
1998, and the reported amounts of revenues and expenses during the years ended
June 27, 1999, June 28, 1998 and June 30, 1997 and 1996.1997. Actual amounts could differ from
those estimates.
Revenue Recognition
The Company recognizes product revenue at the time of shipment or in accordance
with the terms of the relevant contract. Revenue from government contracts is
recorded on the percentage-of-completion method as expenses per contract are
incurred. License fee income is recognized when the transfer of licensed
technology is completed.
31
Contract revenue represents reimbursement by various U.S. Government entities to
aid in the furthering of the development of the Company's technology by
supplementing the Company's research and
-37-
development efforts. Any resulting
technology obtainedThe applicable contracts generally provide that the Company
may elect to retain ownership of inventions made in performing the work, subject
to a non-transferable, non-exclusive license retained by the Company through these efforts remaingovernment to
practice the property of
the Company after the completion of the contract, subject to certain license
rights obtained by the government.inventions for government purposes. Contract revenue includes
funding of direct research and development costs and a portion of the Company's
general and administrative expenses and other operating expenses for contracts
under which funding is expected to exceed direct costs over the life of the
contract. The specific reimbursement provisions of the contracts, including the
portion of the Company's general and administrative expenses and other operating
expenses that are reimbursed, vary by contract. Such reimbursements are recorded
as contract revenue. For contracts under which the Company anticipates that
direct costs will exceed amounts to be funded over the life of the contract
(i.e., certain cost share arrangements), the Company reports direct costs as
research and development expenses with related reimbursements recorded as an
offset to those expenses.
In September 1996, the Company entered into a license and supply agreement with
Shin-Etsu Handotai Co. LTD. ("Shin-Etsu") and other parties to use certain LED
fabrication technology and has agreed to supply silicon carbide wafers required
to manufacture the licensed product. The license agreement provides for payment
of a license fee and royalties based on a percentage of sales of products made
using the licensed technology. The license fee was payable in installments which
totaled $2,700,000. As of June 28, 1998,27, 1999, all license fees have been received. The Company also has recorded a short-term
accrued expense of $186,000 payable in the first quarter of fiscal 1999 to the
third party that brokered the license agreement.
Substantially all of the Company's obligations to transfer the licensed
technology were performed during fiscal 1997 and the net present value of the
license fee payments and commission were recognized. In October 1995, the Company also entered into an
agreement to license its technology for the joint development and manufacture of
LEDs using Cree's technology to Siemens A.G. License fees are payable in
installments totaling $1,500,000. As of June 28, 1998, all fees have been
received. The Company's obligation to transfer the licensed technology was
substantially completed during fiscal 1996, and the net present value of the
license fee payments was recorded as revenue at that time.
Cash and Cash Equivalents
Cash and cash equivalents consist of unrestricted cash accounts and highly
liquid investments with an original maturity of three months or less when
purchased.
Marketable Securities
Investments are accounted for in accordance with Statement of Financial
Accounting Standards No. 115 (SFAS No. 115) "Accounting for Certain Investments
in Debt and Equity Securities". This statement requires certain securities to be
classified into three categories:
(a) Securities Held-to-Maturity- Debt securities that the entity has the
positive intent and ability to hold to maturity are reported at
amortized cost.
(b) Trading Securities- Debt and equity securities that are bought and
held principally for the purpose of selling in the near term are
reported at fair value, with unrealized gains and losses included in
earnings.
(c) Securities Available-for-Sale- Debt and equity securities not
classified as either securities held-to-maturity or trading
securities are reported at fair value with unrealized gains or losses
excluded from earnings and reported as a separate component of
stockholders'shareholders' equity.
32
TheAs of June 27, 1999, the Company's short-term investments consisted of common
stock holdings of Microvision, Inc. ("MVIS"). The Company purchased 268,600
common shares in a private equity transaction in May 1999 at a price of $16.75
per share. In August 1999, MVIS filed a registration statement for the Company's
sale of these shares; however, Cree has agreed not to sell the shares until at
least January 6, 2000. Since the Company is currently restricted from trading
these shares and management views this transaction as an investment, the shares
are comprisedaccounted for as "available for sale"
-38-
securities under SFAS 115. Therefore unrealized gains or losses are excluded
from earnings and reported as a separate component of equity securities
that are classified as trading securities, which are carried at their fair value
based upon quoted market pricesshareholders' equity.
As of those investments at June 28, 1998, the Company's short-term investments consisted of common
stock holdings in C3, Inc ("C3"), the majority of which were bought in November
1997. The Company also acquired additional shares of C3 in September 1998 and
acquired 24,601 shares directly from C3 pursuant to the exercise of an option in
January 1997. This investment was treated for accounting purposes as a trading
security, with net realized and unrealized gains and losses included in net
earnings. All common shares of C3 held by Cree were subsequently sold during
fiscal 1999. Realized gains on shares of C3 stock sold during fiscal 1999 by the
Company were $140,000. This amount was recorded as other income. Approximately
$32,000 of net loss was recorded to other income (expense) in fiscal 1998
related to this investment.
As of June 28, 1998, short-term investments consist of common stock
holdings in C3, Inc. ("C3"), a portion of which were purchased in November 1997.
Thethe Company's president has, through a binding agreement,had promised to indemnify the
Company for losses of up to $300,000, plus the lesser of $100,000 or the net
difference between the per share selling price and $9.375 per share for all
shares of C3 common stock sold by Cree. This indemnity covers losses that mayAs a result, from the sale of shares purchased in November 1997 below the purchase
price paid, offset by gains realized on shares acquired directly from C3 in
January 1997 (see below). Payment of this obligation is due within ten days
after receipt by the president of the Company's written demand made pursuant
to a vote of the majority of the members of the Board of Directors. Atat June 28, 1998, the
Company had recorded a $390,000 receivable from the president
(included in net accounts receivable) based upon this
agreement for the net realized and unrealized losses on this investment. Realized losses onSince
Cree sold its shares of C3 stock sold byfor a net gain, the Company during fiscal 1998 totaled $254,000, and unrealized
losses offset by the unrealized gain on shares acquired from C3 directly (see
below) were $168,000 at June 28, 1998. Approximately $32,000 of losses on the
investment in C3 stock is included in other income (expense) for fiscal 1998.
In addition to the shares of C3 purchased in November 1997, the Company
acquired 24,601 shares of C3 common stock in January 1997. These shares were
issued pursuant to an option C3 granted to the Company in 1995. The option gave
the Company the right to acquire, for an aggregate consideration of $500, one
percent of the outstanding common stock of C3. C3 retained the right to waive
the consideration and issue the stock at any time, which it elected to do in
January 1997. The shares issued pursuant to the option are restricted securities
within the meaning of Rule 144 under the Securities Act of 1933, which permits
the sale of such securities without registration if certain conditions are met.
The shares first became eligible for sale under Rule 144 in the third quarter of
fiscal 1998.indemnity has been terminated
with no payments becoming due.
Inventories
Inventories are stated at the lower of cost or market, with cost being
determined underusing the first-in, first-out (FIFO) method. Inventories consistsconsist of
the following:
June 27, June 28,
June 30,1999 1998
1997
--------------- ------------in (000)s in (000)s
--------- ---------
Raw materials $ 999,0001,290 $ 1,559,000999
Work-in-progress 752,000 1,374,0001,675 752
Finished goods 792,000 1,016,000
--------------- ------------1,012 792
--------- ---------
$ 2,543,000 $ 3,949,000
=============== ============3,977 $2,543
========= =========
Property and Equipment
Property and equipment are recorded at cost and depreciated on a straight-line
basis over the estimated useful lives of the assets, which range from three to
20twenty years. Leasehold improvements are amortized over the life of the related
lease. Expenditures for repairs and maintenance are charged to expense as
incurred. The costs of major renewals and betterments are capitalized and
depreciated over their estimated useful lives. The cost and related accumulated
depreciation of the assets are removed from the accounts upon disposition and
any resulting gain or loss is reflected in operations.
33
During the first quarter of fiscal 1996, the Company changed its
previous estimate on the useful lives of some of its manufacturing equipment
from five to nine years. The change in estimate was based on the Company's
experience with similar fixed assets. The net adjustment increased net income
approximately $280,000, or $0.02 per share, for fiscal 1996.
The Company has entered into an agreementtwo agreements with C3 to sell crystal growth
equipment manufactured by the Company to C3 at cost plus a reasonable overhead
allocation. As a result of this transaction,these transactions, the Company has recognized thean
overhead allocation of $473,000 and $332,000, in fiscal 1999 and fiscal 1998,
respectively, as "other operating income".
-39-
In November 1997, the Company purchased real property consisting of
approximately 30thirty acres of land with a production facility of approximately
162,000139,000 square feet and a total of approximately 35,00033,000 square feet of service
and warehouse buildings. This property is located in Durham, North Carolina, in
the vicinity of the Research Triangle Park. The purchase price offor the land and
buildings was $3,000,000. The Company has now moved mostthe majority of its
salesemployees and administrative
personnelproduction to this facility in January 1998. The Company anticipates it will
relocate several other operations to this facility over the next few quarters.
All areas, with the exception of certain crystal growth and wafer fabrication
assets, are expected to relocate during fiscal 1999.facility.
The Company assesses the realizability of the carrying value of its investment
in property and equipment whenever events or changes in circumstance indicate
that an impairment may have occurred in accordance with the provisions of
Statement of Financial Accounting Standards No. 121 ("SFAS No. 121"),
"Accounting for Impairment of Long Lived Assets and Assets to be Disposed of".
As of June 28, 1998,27, 1999, the Company has not recorded any impairment in the carrying
value of its property and equipment.
Patent and License Rights
Patent rights reflect costs incurred to enhance and maintain the Company's
intellectual property position. License rights reflect costs incurred to use the
intellectual property of others. Both are amortized on a straight
linestraight-line basis.
During fiscal 1997, the Company changed its previous estimate of the useful liveslife
of patents from 17 years, beginning at the date of patent issue, to 20 years
from the date of patent applicationapplication. This change was made to conform to a
legislative amendment made to the U.S. patent laws, which became effective in
June 1995. This change in estimate had no material impact to net income or
earnings per share, since the average period of time between patent application
and issue is generally about three years. Amortization expense was $117,000,
$102,000 $108,000 and $126,000,$108,000 for the years ended June 27, 1999, June 28, 1998 and June
30, 1997, and 1996, respectively. Total accumulated amortization for patents was
approximately $560,000$669,000 and $460,000$560,000 at June 28, 199827, 1999 and June 30, 1997,28, 1998,
respectively.
Goodwill
Goodwill represented the amount by which the costs to acquire the net assets of
the Real Color Displays subsidiary exceeded their related fair value at
acquisition. Based on a review of undiscounted cash flows of the subsidiary
anticipated over the remaining amortization period, the Company determined that
goodwill had been impaired. As a result, the Company wrote off the remaining
$66,000 carrying value of such goodwill in the second quarter of fiscal 1998. As
required by generally accepted accounting principles, this charge was included
in the results of operations.
Research and Development Policy
The Company partnerscontracts with the FederalU.S. government infor many of its current research
and development efforts. By entering into these contracts, the Company has most
of its research and product development costs funded by the U.S. government. The
contract funding may be based on a cost-plus or a cost-share
34
arrangement.
Pursuant to each contract, the amount of funding is determined based on cost
estimates that include direct costs, plus an allocation for research and
development, general and administrative and athe cost of capital expense.expenses.
Cost-plus funding is determined based on actual costs plus a set percentage
margin. For the cost-share contracts, the actual costs are divided between the
U.S. government and the Company based on the terms of the contract. The
government's cost share is then funded to the Company. Activities performed
under both of these arrangements include research regarding silicon carbide and
gallium nitride materials. The contracts typically
require the submission of a written report that documents the results of such
research.
Funding on contracts under which the Company anticipates that funding will
exceed direct costs over the life of the contract is recorded as contract
revenue and related costs are reported as a cost of contract revenue.
-40-
For contracts under which the Company anticipates that direct costs will exceed
amounts to be funded over the life of the contract, direct costs are shown as
research and development expenses and related funding as an offset of those
expenses. The following table details information about contracts for which
direct expenses exceed funding by period as reflected in the statements of
operations:
Year ended (in 000's)000s)
June 27, June 28, June 30,
June 30,1999 1998 1997 1996
-------- -------- --------
Net research and development costs $ -- $ 276 $ 671
$ 368
Government funding -- 601 2,186
1,918
------ ------ -------------- -------- --------
Total direct costs incurred $ -- $ 877 $2,857 $2,286
====== ====== ======$ 2,857
======== ======== ========
As of June 28, 1998, all funding under contracts where the Company anticipates
that direct costs will exceed amounts to be funded has been exhausted.
Therefore, the Company anticipates that all future funding under existing
contracts will be reflected as contract revenue while direct costs will be
reported as contract cost of revenue.
Interest Capitalization
During the yearfiscal years ended June 27, 1999 and June 28, 1998, the Company
capitalized interest on funds used to construct property, plant and equipment in
connection with the newly acquired facility. Interest capitalized duringfor the fiscal
1999 and 1998 was $128,000.$128,000 and $128,000, respectively.
Credit Risk, Major Customers and Major Suppliers
Financial instruments, which potentiallymay subject the Company to a concentration of
credit risk, consist principally of cash equivalents and accounts receivable.
The Company's cash equivalents consist of U.S. Treasury
bills, government agency bonds and commercial paper. Certain bank
deposits may at times be in excess of the FDIC insurance limit.
The Company sells its products to manufacturers and researchers worldwide and
generally requires no collateral. The Company maintains reserves for potential
credit losses, and such losses, in the aggregate, have generally been within
management's expectations. The Company presently derives primarily all of its
contract revenues from contracts with the U.S. Department of Defense.
Approximately 18%10% and 33%18%, respectively, of the Company's accounts receivable
balance at June 28, 199827, 1999 and June 30, 199728, 1998 was due from the Department of
Defense. In addition, the Company had amounts due from Siemens A.G. (or its
indirect subsidiary, Osram) totaling 37%35% and 35
19%37%, of accounts receivable
balances at June 27, 1999 and June 28, 1998, respectively. At June 27, 1999 and
June 30, 1997,
respectively, and28, 1998, the Company had amounts due from C3 totaling 23%17% and 1%23%,
respectively, of accounts receivable balances at June 28, 1998 and June 30, 1997, respectively.balances.
The Company has derived its product revenue from sales primarily in the United
States, the Far East, and Europe as follows:
Year Ended
1999 1998 1997 1996
---- ---- ----
United States ...................States....... 38% 26% 21%
31%
Far East ........................ 15%East............ 50% 49% 33%
27%
Europe .......................... 58%Europe.............. 11% 24% 44%
38%
Other ...........................Other............... 1% 1% 2%
4%-41-
One customer accounted for 51%37%, 40% and 46%31% of product revenue for fiscal 1999, 1998 and
1997, respectively. Another customer accounted for 13%19%, 11% and 2% of product revenue
for fiscal 1999, 1998 and 1997, respectively. In addition, two
customers accounted for 32% of product revenue in fiscal 1996. The Department of Defense
accounted for 93%100%, 99%93% and 97%99% of contract revenues during fiscal 1999, 1998,
1997, and 1996,1997, respectively.
The Company depends on single or limited source suppliers for a number of raw
materials and components used in its SiC wafer products and LEDs. Any
interruption in the supply of these key materials or components could have a
significant adverse effect on the Company's operations.
Earnings Per Share Data
Basic earnings per common share is computed using the weighted average number of
common stock shares outstanding. Diluted earnings per common share is computed
using the weighted average number of common stock shares outstanding adjusted
for the incremental shares attributed to outstanding options to purchase common
stock.
Incremental shares of 631,000, 670,000 and 789,000 in 1998, 1997 and
1996, respectively, were used in the calculation of diluted earnings per common
share.
Accounting for Stock Based Compensation
In accordance with Accounting Principles Board Opinion No. 25, Accounting for
Stock Issued to Employees, no compensation is recorded for stock options or
other stock-based awards that are granted to employees with an exercise price
equal to or above the common stock price on the grant date.
Compensation related to performance share grants is recognized from the grant
date until the performance conditions are satisfied, based on the market price
of the Company's common stock.
In October, 1995, the Financial Accounting Standards Board ("FASB") issued
Statement No. 123 ("FAS 123"), "Accounting for Stock Based Compensation." This
Statement establishes fair value as the measurement basis for equity instruments
issued in exchange for goods or services and stock-based compensation plans.
Fair value may be measured using quoted market prices, option-pricing models or
other reasonable estimation methods. FAS 123 permits the Company to choose
between adoption of the fair value based method or disclosing pro forma net
income information. The Statement is effective for transactions entered into
after December 31, 1995. The Company will continue to account for stock-based
compensation in accordance with Accounting Principles Board Opinion No. 25, as
amended, and provide only the pro forma disclosures required by FAS 123.
3. ACCOUNTS RECEIVABLE
36
The following is a summary of accounts receivable:
June 27, 1999 June 28, 1998
June 30, 1997(in 000s) (in 000s)
------------- -------------
Trade receivables $ 8,971,00014,685 $ 5,210,0008,971
Other short term receivables 1,659,000 2,700,000
----------- -----------
10,630,000 7,910,0001,775 1,659
------------- --------------
16,460 10,630
Allowance for doubtful accounts 151,000 216,000
----------- -----------
Current receivables 10,479,000 7,694,000
Long term receivables 56,000 54,000
----------- -----------(175) (151)
------------- --------------
Total accounts receivable $10,535,000 $ 7,748,000
=========== ===========16,285 $ 10,479
============= ==============
-42-
The following table summarizes the changes in the Company's allowance for
doubtful accounts for the years ended June 27, 1999, June 28, 1998 and June 30,
1997:
June 27, June 28, June 30,
1999 1998 1997
and 1996:
Allowance for Doubtful Accounts:
(dollars in thousands)(in 000s) (in 000s) (in 000s)
--------- --------- ---------
Balance At Charges To Deductions Balance At
Years Beginning Cost and (Write-offs Endat beginning of Ended of Period Expenses Charged To Reserve) Period
- ----- --------- -------- ------------------- ------
1998year $ 151 $ 216 $ 50
Charges to cost and expenses 24 50 190
Deductions (write-offs to reserve) -- (115) (24)
--------- --------- ---------
Balance at end of year $ 175 $ 151 1997 $ 50 190 (24) $ 216
1996 $ 22 203 (175) $ 50========= ========= =========
4. PROPERTY AND EQUIPMENT
The following is a summary of property and equipment:
June 27, June 28,
1999 1998
June 30, 1997
------------ -------------(in 000s) (in 000s)
--------- ---------
Office equipment and furnishings....... $1,372,000 $909,000furnishings $ 1,948 $ 1,372
Land and buildings .................... 3,501,000 -& Buildings 21,031 3,501
Machinery and equipment................ 28,136,000 22,312,000equipment 46,199 28,136
Leasehold improvements 1,549 4,697
--------- ---------
70,727 37,706
Accumulated depreciation (13,311) (10,304)
--------- ---------
57,416 27,402
Construction in progress............... 9,074,000 2,669,000
Leasehold improvements................. 4,697,000 5,420,000
------------ -------------
46,780,000 31,310,000
Accumulated depreciation and
amortization......................... (10,304,000) (6,977,000)
------------ -------------
$36,476,000 $24,333,000
============ =============progress 12,468 9,074
--------- ---------
Net Property & Equipment $69,884 $36,476
========= =========
Depreciation and amortization of property and equipment totaled $5,382,000,
$4,217,000 $3,356,000 and $1,765,000$3,356,000 for the yearyears ended June 27, 1999, June 28, 1998 and
June 30, 1997, and June 30, 1996, respectively.
37
5. SHAREHOLDERS' EQUITY
The BoardAt June 27, 1999, the Articles of Directors isIncorporation of the Company authorized the
Company to issue 1,250,000 and 1,500,000up to 30,000,000 shares of Class A Votingcommon stock, with a par value of
$0.005 per share, and Class B Non-Voting3,000,000 shares of preferred stock, respectively,
each with a par value of
$0.01 per share, at its discretion. Thisshare. The preferred stock may be issued in one or more classes or
series with the number of shares, designation, relative rights, preferences, and
limitations of each class or series to be determined by resolution of the Board
of Directors. The Articles of Incorporation were amended, effective at the close
of business on July 26, 1999, to effect a two-for-one split of the common stock.
As a result, as of the effective date of the amendment, the Articles of
Incorporation authorize the Company to issue up to 60,000,000 shares of common
stock, with a par value of $0.0025 per share. The amendment did not change the
number of authorized shares or other provisions relating to the preferred stock.
All share numbers have been restated to give effect to the stock split.
On February 17, 1999, the Company completed a public offering selling 2,990,000
shares of its common stock at a price of $19.69 per share. The Company received
net aggregate proceeds of approximately $55.2 million after deducting
underwriter discounts and estimated offering costs. A portion of the net
-43-
proceeds, $10 million, was used to repay debt to a commercial bank. The majority
of the funds are being used for plant expansion and the balance for general
corporate purposes, including working capital and potential acquisition of or
investments in complementary businesses.
6. STOCK OPTIONS AND STOCK WARRANTS
As permitted by FAS 123, "Accounting For Stock-Based Compensation", the Company
has elected to follow Accounting Principles Board Opinion No. 25, "Accounting
for Stock Issued to Employees" and related interpretations and amendments in
accounting for its employee stock option plans.
The Company's Amended and Restated Equity Compensation Plan has authorized the
grant of options for up to 2,540,0005,400,000 shares of the Company's common stock. All
options granted have 10 year terms and vest and become fully exercisable within
5 years. The Company had granted 96,000192,000 options with a 10 year term for shares
of the Company's common stock under the Stock Option Plan for Non-Employee
Directors (Directors Formula Plan).Directors. This Planplan was terminated in November 1997 and all 96,000192,000 options
granted under this plan are now fully vested. The Company's current stock plans
provide for grants of options with exercise prices equal to or exceeding fair
market value on the date of grant.
Pro forma information regarding net income and earnings per share is required by
Statement 123, and has been determined as if the Company had accounted for its
employee stock options under the fair value method of the Statement. The fair
value of these options was estimated at the date of grant using a Black-Scholes
option pricing model with weighted average risk free rates of interest of 5.6%5.3%
and 6.7%5.6%, for the years ended June 28, 199827, 1999 and June 30,
1997,28, 1998, respectively. The
volatility factor of the expected market price of the Company's common stock is
.7481.174 and the weighted-average expected life of the options was 7 years for
executives and directors and 5 years for other employees.
For purposes of pro-forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. The
Company's pro forma information is as follows:
YEARS ENDED
-----------------------------------------
JUNEJune 27, June 28, JUNEJune 30,
JUNE 30,1999 1998 1997
1996
---------- ----------(in 000s) (in 000s) (in 000s)
--------- --------- ---------
Net income, as reported $ 6,275,00012,702 $ 3,542,000 $243,0006,275 $3,542
Pro forma net income, as adjusted 8,968 4,405 1,418
for FAS 123 4,405,000 1,418,000 243,000
Pro forma earnings per share:
Basic $ 0.340.33 $ 0.110.17 $ 0.02
If0.05
Diluted $ 0.330.32 $ 0.110.16 $ 0.02
38
0.05
The following table details the number of stock options outstanding and their
related exercise prices as of June 28:27, 1999:
-44-
Number of Options Outstanding As Ofas of June 28, 1998
-------------------------------------------------27, 1999
Weighted-Average
Exercise Price Number of Weighted-Average
Price Options Contractual Life
-------- --------- ----------------------------- ----------------- ----------------
$ 0.42 5,497 20.21 2,866 1 year
$ 1.56 16,000 5 years
$ 3.131.81 322,584 4 years
$ 1.88 10,668 1 year
$ 2.00 87,200 5 years
$ 2.19 12,000 5 years
$ 3.41 8,000 4 years
$ 3.69 12,000 5 years
$ 4.69 38,800 8 years
$ 5.13 21,400 8 years
$ 5.60 26,900 7 years
$ 6.49 752,200 8 years
$ 7.13 46,000 9 years
$ 7.19 330,950 6 years
$ 3.63 250,200 57.63 1,189,800 9 years
$ 3.75 13,317 37.88 96,000 7 years
$ 4.00 78,700 68.19 38,400 9 years
$ 4.38 6,000 68.38 10,000 9 years
$ 6.82 6,700 5 years
$ 7.38 6,000 68.88 33,600 9 years
$ 9.38 26,600 9 years
$ 10.25 14,500 9 years
$ 11.19 16,80071,800 8 years
$ 12.98 409,1009.69 20,000 9 years
$ 14.38 203,400 7$12.32 114,000 9 years
$ 15.75 48,000 8 years
$ 16.38 43,500$20.50 134,400 10 years
$ 17.75 19,000$22.60 139,600 10 years
$ 18.75 40,000 9 years
$ 19.38 10,000$22.63 78,000 10 years
---------
1,205,314
=========
39
Total Option Activity
-------------------------------------------------------------------
June 28, 1998 June 30, 1997 June 30, 1996
Weighted Weighted Weighted
Options Average Options Average Options Average
(in 000's) Price (in 000's) Price (in 000's) Price
-------- ------- ------------------ --------------------
Outstanding-beginning of year 927 $ 4.76 632 $ 4.39 769 $ 4.23
Granted 542 $13.98 381 $ 13.56 - $ -
Exercised 217 $ 7.80 52 $ 3.08 122 $ 3.39
Forfeited 47 $ 8.67 34 $ 8.05 15 $ 4.36
-------- ------ -------
Outstanding-end of year 1205 $10.19 927 $ 4.76 632 $ 4.39
Exercisable at end of year 599 $ 8.40 702 $ 7.44 439 $ 3.78
During fiscal year 1992, the Company issued stock warrants to
purchasers of Class B Non-Voting preferred stock, Series C. The warrants
entitled the holders to purchase 607,320 shares of common stock at $3.75 per
share. In September 1992, the Company issued stock warrants to additional
purchasers of Class B Non-Voting preferred stock, Series C. The warrants
entitled the holders to purchase 363,644 shares of common stock at $4.13 per
share. Warrants to purchase 331,326, 202,996 and 425,642 shares of common stock
were exercised during the years ended-----------------
3,613,168
Total Option Activity
-------------------------------------------------------------
June 27, 1999 June 28, 1998 June 30, 1997
and 1996,
respectively. All remaining warrants expired effective February 8, 1998.Weighted Weighted Weighted
Options Average Options Average Options Average
(in 000s) Price (in 000s) Price (in 000s) Price
--------- -------- --------- -------- --------- --------
Outstanding -
beginning of year 2,410 $ 5.10 1,854 $ 2.38 1,264 $ 2.20
Granted 1,712 $10.85 1,084 $ 6.99 762 $ 6.78
Exercised (418) $ 3.63 (434) $ 3.90 (104) $ 1.54
Forfeited (91) $ 7.08 (94) $ 4.34 (68) $ 4.03
--------- --------- ---------
Outstanding -
end of year 3,613 $ 8.14 2,410 $ 5.10 1,854 $ 2.38
Exerciseable at
end of year 1,478 $ 5.39 1,198 $ 4.20 1,404 $ 3.72
-45-
In connection with the Company's September 1995 private placement, the Company
issued an additional 300,000600,000 warrants, which have an exercise price of $27.23$13.62, which
represents fair value on the date of grant, and expire September 2000. AsWarrants
to purchase 342,000 shares of common stock were exercised during the fiscal year
ended June 27, 1999. Warrants to purchase 258,000 shares remain outstanding as
of June 28, 1998, all of these warrants
remain outstanding27, 1999 and represent the only warrants outstanding.
7. LEASE COMMITMENTS
The Company currently leases three facilities under four separate lease
agreements.facilities. These facilities are comprised of
both office and manufacturing space. The first facility has a remaining lease
period of approximately threetwo and one half years for a multi-suite block. Effective May 1, 1998, the Company
has notified the lessor of its intention to exercise a right to terminate for
all suites with the exception of the base suite. This right to terminate will be
effective May 1, 1999. Also associated with this facility is a sublease
agreement entered into in fiscal 1996 to lease an adjacent 1,900 square feet.
That sublease expires in October 1998 and will not be renewed.years. The lease term for the second
facility began in September 1995. This facility has a remaining lease period of
approximately two yearsone-year with two options to renew for a total of four additional
years. The lease for the third facility expires in December 1999. All of these
agreements provide for rental adjustments for increases in property taxes, the
consumer price index and general property maintenance.
Rent expense associated with these and other expired leases totaled $430,000,
$522,000 $549,000
and $388,000$549,000 for the years ended June 27, 1999, June 28, 1998, and June
30, 1997, and 1996,
respectively. Future minimum rentals as of June 28, 199827, 1999 under these
leases are as follows:
40
MinimalMinimum Rental
YearFiscal Years Ended Amount
---------- -----------
1999(in 000s)
------------------ --------------
June 25, 2000 $ 389,000
2000 334,000312
June 24, 2001 284,000247
June 30, 2002 138,000119
-----
Total $ 1,145,000678
=====
8. LONG-TERM DEBT
In November 1997, the Company entered into a term loan fromwith a commercial bank
for up to $10,000,000 to finance the purchase and upfit of the new main facility
in Durham, North Carolina. Approximately $2,950,000 was disbursed under the loan
to finance the initial purchase of the facility with the remaining proceeds
expected to be disbursed on a monthly basis based on actual expenditures incurred. Draws under the loan agreement may be made during
the eighteen month period ending in May 1999. The loan,
which iswas collateralized by the purchased property and subsequent upfits,
accruesaccrued interest at a fixed rate of 8% and carriescarried customary covenants,
including the maintenance of a minimum tangible net worth and other
requirements. Accrued interest is due
monthly through MayOn February 17, 1999, at which time the outstanding principal balance will
be amortized over twenty years until 2011, whenentire $10,000,000 indebtedness was
repaid with proceeds received from the loan balance becomes due.public stock offering. At June 28, 1998,
short term and long term borrowings associated with this loan were $17,000 and
$8,650,000, respectively, leaving $1,333,000 unused and
available.
The aggregate maturities for long-term debt for the five years after
June 28, 1998 are :
Amount
Year Ended Due
---------- ------------
1999 $ 17,000
2000 213,000
2001 230,000
2002 250,000
2003 270,000
Thereafter 7,687,000
------------
Total $ 8,667,000
============respectively.
9. INCOME TAXES
The Company accounts for its income taxes under the provisions of Statement of
Financial Accounting Standards No. 109 ("FAS 109"), "Accounting for Income
Taxes." Under the asset and liability method of FAS 109, deferred tax assets and
liabilities are recognized for the estimated future tax consequences
attributable to differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax bases. Deferred tax
assets and liabilities are measured using enacted tax rates in effect for the
year in which those temporary differences are expected to be recovered or
-46-
settled. Under FAS 109, the effect on deferred tax assets and liabilities of a
change in tax rates is recognized in income in the period that includes the
enactment date.
41
The actual income tax expense attributable to earnings for the years ended June 29, 1999, June 28, 1998,
and June 30, 1997 and 1996 differed from the amounts computed by applying the U.S.
federal tax rate of 34 percent35% in fiscal 1999, and 34% in fiscal 1998 and 1997, to
pretax earnings as a result of the following:
1998 1997 1996
------------- ----------- ----------
Federal income tax provision at statutory
rate (34%) $ 3,018,000 $ 1,265,000 $ 83,000
State tax provision 166,000 193,000 36,000
Increase (decrease) in income tax expense
resulting from:
Foreign sales corporation (214,000) - -
Increase (decrease) in valuation allowance (358,000) (1,279,000) (106,000)
Other (12,000) (2,000) (13,000)
------------- ----------- ----------
Income tax expense $ 2,600,000 $ 177,000 $ -
============= =========== ==========
June 27, June 28, June 30,
1999 1998 1997
(in 000s) (in 000s) (in 000s)
--------- --------- ---------
Federal income tax provision at $ 6,174 $ 3,018 $ 1,265
statutory rate
State tax provision 211 166 193
Increase (decrease) in income tax
expense resulting from:
Foreign sales corporation (510) (214) --
Decrease in valuation allowance (290) (358) (1,279)
Research and development (251) -- --
State tax credits (394) -- --
Other -- (12) (2)
--------- --------- ---------
Income tax expense $ 4,940 $ 2,600 $ 177
========= ========= =========
The following are the components of the provision for income taxes for the years
ended June 27, 1999, June 28, 1998 and June 30, 1997:
June 27, June 28, June 30,
1999 1998 1997
----------(in 000s) (in 000s) (in 000s)
--------- --------- ---------
Current:
Federal $ 699,0002,553 $ 54,000699 $ 54
Foreign Tax Withholding 50,000 220,000-- 50 220
State 269,000 95,000
----------300 269 95
--------- 1,018,000 369,000--------- ---------
2,853 1,018 369
Deferred:
Federal 1,582,000 (442,000)2,347 1,582 (442)
State - 250,000
----------(260) -- 250
--------- 1,582,000 (192,000)
---------- --------- ---------
2,087 1,582 (192)
Net Provision $ 2,600,000 $177,0004,940 $ 2,600 $ 177
========== ========= There is no tax provision for fiscal 1996.=========
-47-
The tax effects of temporary differences that give rise to significant portions
of the deferred tax assets and deferred tax liabilities are as follows:
42
June 27, 1999 June 28, June 30,
1998
1997
---------- ----------(in 000s) (in 000s)
------------- -------------
Deferred tax assets:
Net operating loss carryforwards $ 1,304,00097 $ 2,413,0001,304
Research tax credits 169,000 157,000420 169
Compensation 62,000 115,000105 62
Inventory 120,000 199,000126 120
Bad debt 56,000 84,000
Goodwill -- 31,00065 56
Alternative minimum tax 261,000 64,0001,513 261
Foreign tax credit 270,000 220,000270 270
Other 527 --
10,000
----------- ------------------------ -------------
Total gross deferred tax assets 2,242,000 3,293,0003,123 2,242
Less valuation allowance (290,000) (1,463,000)
----------- -----------
Net-- (290)
------------- -------------
Total net deferred tax asset 1,952,000 1,830,000assets 3,123 1,952
Deferred tax liabilities:
Marketable equity securities 658 --
Property and equipment due
to depreciation 2,154,000 1,638,000
----------- -----------3,992 2,154
------------- -------------
Gross deferred tax liabilities 2,154,000 1,638,000
----------- -----------4,650 2,154
------------- -------------
Net deferred tax asset (liability)liability $ (202,000)(1,527) $ 192,000
=========== ===========(202)
============= =============
The net change in the total valuation allowance for the years ended June 27,
1999 and June 28, 1998 and June 30, 1997 was $1,173,000 and $1,201,000, respectively.
Included in the valuation allowance is $0 and $815,000, respectively, for 1998
and 1997 to offset net operating losses ("NOL") generated by the exercise of
stock options. The reduction in the valuation allowance does not impact the 1998
tax provision as such taxes are reflected in additional paid in capital.$290,000. The primary reason for the reduction in the
valuation allowance in 19981999 and 19971998 was the greater likelihood of the
utilization of future tax benefits from net operating loss ("NOL")
carryforwards. Realization of deferred tax assets associated with the NOL
carryforwards is dependent upon the Company generating sufficient taxable income
prior to their expiration. Management believes that there is a risk that certain
of the state NOL carryforwards may expire unused and, accordingly, has
established a valuation allowance against them. Although realization is not
assured for the remaining deferred tax assets, management believes it is more
likely than not that they will be realized through future taxable earnings.
However, the net deferred tax assets could be reduced in the future if
management's estimates of taxable income during the carryforward period are
significantly reduced.
As of June 28, 1998,27, 1999, the Company has net operating loss carryforwards for
Federalfederal purposes of $3,493,000$75,000 and $2,346,000$1,400,000 for state purposes. The carryforward
expiration period is 2011 to 20132019 for Federalfederal tax purposes and from 2000 to 20032004
for state purposes.
43
10. ACQUISITION
In August 1994, the Company formed a North Carolina wholly-owned
subsidiary, RCD, to develop and market full color LED displays. Subsequently,
RCD acquired the net assets of Color Cells International, Ltd., a Hong-Kong
based company in this line of business, for cash consideration of $215,000 and
assumption of $152,000 of liabilities. The terms of the acquisition called for
an "Earn-Out Payment" based on calculated net profits, payable half in cash and
half in Cree common stock. Earn-Out Payments were subject to certain limitations
concerning the timing (calculation based on certain eligible shipments through
September 1997) and amount (maximum payments of $1.8 million) of any such
payments. As of the end of the earn-out period in September 1997, no amounts had
been earned or paid under this agreement.
11. RETIREMENT PLAN
The Company maintains an employee benefit plan (the "Plan") pursuant to Section
401(k) of the Internal Revenue Code. Under the Plan, there is no fixed dollar
amount of retirement benefits, and actual benefits received by employees will
depend on the amount of each employee's account balance at the time of
retirement. All employees are eligible to participate under the Plan on the
first day of a new fiscal quarter after date of hire. The Plan is not insured by
the Pension Benefit
Guaranty Corporation.Corporation does not insure the Plan. The
-48-
Company may, at its discretion, make contributions to the Plan. However, the
Company did not make any contributions to the Plan during the years ended June
27, 1999, June 28, 1998 or June 30, 1997 or 1996.
12. CONTINGENCIES
The consolidated securities class action lawsuits previously pending
against the Company and certain of its directors and officers in the U.S.
District Court for the Middle District of North Carolina were dismissed with
prejudice on November 28, 1997.
The dismissal was pursuant to a stipulation of
the named parties entered after the court granted the defendant's motions to
dismiss the consolidated complaint for failure to state a claim. No payments
were made to the plaintiffs to obtain the dismissal. By stipulating to the
dismissal with prejudice, the plaintiffs waived any right to re-file the action
or to appeal the court's order of dismissal.
13.11. EARNINGS PER SHARE
The Company has adopted Statement of Financial Accounting Standards (SFAS)
No. 128, "Earnings Per Share", as of December 28, 1997. SFAS No. 128
required the Company to change its method of computing, presenting and
disclosing earnings per share information. All prior period data presented
has been restated to conform to the provisions of SFAS No. 128.
The following computation reconciles the differences between the basic and
diluted presentations:
44
Year Ended
-------------------------------------
June 28, June 30, June 30,
1998 1997 1996
----------- ----------- ----------
Basic:
Net income $ 6,275,000 $ 3,542,000 $ 243,000
=========== =========== ==========
Weighted average common shares 12,862,917 12,455,494 11,825,857
=========== =========== ==========
Basic income per common share $ 0.49 $ 0.28 $ 0.02
=========== =========== ==========
Diluted:
Net income $ 6,275,000 $ 3,542,000 $ 243,000
=========== =========== ==========
Weighted average shares:
Common shares outstanding 12,862,917 12,455,494 11,825,857
Dilutive effect of stock options & warrants 630,533 670,048 789,107
----------- ----------- ----------
Total shares and common share equivalents 13,493,450 13,125,542 12,614,964
=========== =========== ==========
Diluted income per common share $ 0.47 $ 0.27 $ 0.02
=========== =========== ==========
14.June 27, June 28, June 30,
1999 1998 1997
(in 000s) (in 000s) (in 000s)
--------- --------- ---------
Basic:
Net income $ 12,702 $ 6,275 $ 3,542
========= ========= =========
Weighted average common shares 27,015 25,726 24,911
========= ========= =========
Basic income per common share $ 0.47 $ 0.24 $ 0.14
========= ========= =========
Diluted:
Net income $ 12,702 $ 6,275 $ 3,542
========= ========= =========
Weighted average common
shares-basic 27,105 25,726 24,911
Dilutive effect of stock options
& warrants 1,417 1,261 1,340
--------- --------- ---------
Weighted average common
shares-diluted 28,432 26,987 26,251
========= ========= =========
Diluted income per common share $ 0.45 $ 0.23 $ 0.13
========= ========= =========
Potential common shares that would have the effect of increasing diluted income
per share are considered to be antidilutive. In accordance with SFAS No. 128,
these shares were not included in calculating diluted income per share. As of
June 27, 1999, there were no potential shares considered to be antidilutive. For
the years ended June 28, 1998 and June 30, 1997, there were 225,000 and 574,000
shares, respectively, that were not included in calculating diluted income per
share because their effect was antidilutive.
12. NEW ACCOUNTING PRONOUNCEMENTS
TheIn fiscal 1999, the Company will adoptadopted Statement of Financial Accounting Standards
No. 130, "Reporting Comprehensive Income" ("SFAS No. 130"), which establishes
standards for reporting and display of comprehensive income and its components
in a full set of general-purpose financial statements. SFAS 130 only impacts
financial statement presentation as opposed to actual amounts recorded. Other
comprehensive income includes all non-owner changes in equity that are excluded
from net income. For fiscal 1999, the Company reports accumulated gains on
available-for-sale investment securities that are accumulated in shareholders'
equity as an item of other comprehensive income. At the time of the sale, any
previously recognized gains or losses that were accumulated in shareholders'
equity would be reversed in comprehensive income and then recognized as an
element of net income. For the year ended June 27, 1999. SFAS No. 130 requires28, 1998, the Company to display an amount representing
totalhad no
items of other comprehensive income forincome.
-49-
In fiscal 1999, the period in a financial statement which is
displayed with the same prominence as other financial statements. Upon adoption,
all prior period data presented will be restated to conform to the provisions of
SFAS No. 130. The application of the new pronouncement is not expected to have a
material impact on the Company's financial statements.
The Company will adoptadopted Statement of Financial Accounting Standards No. 131,
"Disclosures about Segments of an Enterprise and Related Information" ("SFAS
No. 131") for. SFAS 131 changes the year ended June 27, 1999. SFAS No. 131 requires the Companyway public companies report segment information in
annual financial statements and also require those companies to report selected
segment information about operating segments in itsinterim financial statements. Itstatements to shareholders. SFAS 131
also establishes standards for related disclosures about products and services,
geographic areas, and major customers. The application of the new pronouncement isrules does not expected to
have a materialsignificant impact on the Company's disclosures.financial statements as the Company
only operates in a single segment.
In June 1998, The Financial Accounting Standards Board issues Statement No. 133
"Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133"),
which is required to be adopted in years beginning after June 15, 1999. Because
of the Company's minimal use of derivatives, management does not anticipate that
the adoption of the new Statement will have a significant effect on earnings or
the financial position of the Company.
13. SUBSEQUENT EVENT
On July 13, 1999 the Company filed a Form 8-K announcing a two-for-one split of
its common stock. The stock split was effected by an amendment to the Company's
Articles of Incorporation that became effective at the close of business on July
26, 1999. With the effectiveness of the amendment, each issued and unissued
authorized share of common stock, $0.005 par value per share, was automatically
split into two whole shares of common stock, $0.0025 par value per share. On
July 30, 1999, the Company issued to each holder of record of common stock a
certificate evidencing the additional shares of common stock resulting from the
stock split. All references in this document to common stock and per common
share data have been adjusted to reflect the common stock split.
Item 9.Changes9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
PART III
45
Item 10. Directors and Executive Officers
Item 11. Executive Compensation
Item 12. Security Ownership of Certain Beneficial Owners and Management
Item 13. Certain Relationships and Related Transactions
The information called for in items 10 through 13 is incorporated by reference
from the Company's definitive proxy statement relating to its annual meeting of
stockholders, which will be filed with the Securities and Exchange Commission
within 120 days after the end of fiscal 1998.1999.
-50-
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) (1) and (2) Financial statements and financial statement schedule - the
financial statements financial statements schedule, and reportreports of independent accountantsauditors are filed as part of
this report (see index to Consolidated Financial Statements at Part II Item 8 on
page 2330 of this Form 10-K). The financial statement schedules are not included
herein as they are either not applicable or are included as part of the
consolidated financial statements.
(a) (3) The following exhibits have been or are being filed herewith and are
numbered in accordance with Item 601 of Regulation S-K:
Exhibit
No. DescriptionEXHIBIT
NO. DESCRIPTION
------- --------------------------------------------------------------------
3.1 Articles of Incorporation, as amended to dateJuly 26, 1999
3.2 Bylaws, as amended to dateMay 28, 1999
4.1 Specimen Common Stock Certificate adopted July 21, 1999
10.1 Amended and Restated Equity Compensation Plan, of the
Company, as amended June 28,
1999*
10.2 Stock Option Plan for Non-Employee Directors (terminated as to
date
10.2 Lease Agreements for Meridian Parkway facilityfuture grants pursuant to Board action dated February 10, 1988, as amended from time to time through
August 25, 1992(1)
10.3 Amendments to Lease Agreements for the Meridian Parkway
facility dated April 12, 1993 and June 15, 1993(2)September 1, 1997) (1)*
10.3 License Agreement between the Company and North Carolina State
University dated December 3, 1987(1)1987 (2)
10.4 Amendment to License Agreement between the Company and North
Carolina State University dated September 11, 1989(1)1989 (2)
10.5 Agreement between General Instrument CorporationDevelopment, License and the
Company dated June 24, 1988(1)
46
10.6 LetterSupply Agreement with General Instrument Corporation dated
February 21, 1992, superseding agreement dated June 24,
1988(1)
10.7 Contract between the Company and
Siemens A.G. dated October 24, 1995(3)
10.81995 (3)
10.6 Purchase Agreement between the Company and Siemens A.G. dated
September 11,6, 1996 (4)
10.9 License and Technology Transfer Agreement between the
Company and Shin- Etsu Handotai Co. Ltd dated September 30,
1996 (5)
10.10 Supply Agreement between the Company and Shin-Etsu
HandotaiCo. Ltd, dated September 30, 1996 (5)
10.1110.7 First Amendment to Purchase Agreement between the Company and
Siemens A.G. dated April 22, 1997 (6)
10.12(5)
10.8 Second Amendment to Purchase Agreement between the Company and
Siemens A.G. dated December 9, 1997 (7)
10.13(6)
10.9 Third Amendment to Purchase Agreement between the Company and
F. Neal HunterSiemens A.G. dated December 28, 1997.
10.14 Amended and Restated IndemnitySeptember 8, 1998 (7)
10.10 Fourth Amendment to Purchase Agreement between the Company and
F. Neal HunterSiemens A.G. dated June 26, 1998.
11.00December 16, 1998 (8)
10.11 Transformation Agreement with Siemens A.G. and OSRAM Opto
Semiconductors GmbH & Co. OHG effective January 1, 1999
11.1 Computation of Per Share Earnings
21.0021.1 Subsidiaries of Registrant 23.00(9)
23.1 Consent of Independent Accountants
27.00Ernst & Young LLP
23.2 Consent of PricewaterhouseCoopers LLP
27.1 Financial Data Schedule
(for SEC use only)-51-
(1) Incorporated by reference herein. Filed as an exhibit to the Company's
Registration Statement filed on Form S-8, Registration No. 33-98958, and
effective with the Securities and Exchange Commission on November 3, 1995.
(2) Incorporated by reference herein. Filed as an exhibit to the Company's
Registration Statement filed on Form SB-2, Registration No. 33-55998, and
declared effective by the Securities and Exchange Commission on February 8,
1993 and bearing Registration
#33-55998.
(2)Incorporated by reference herein. Filed as an exhibit to the Company's annual
report filed on Form 10-KSB with the Securities and Exchange Commission on
August 1, 1993.
(3)Incorporated by reference herein. Filed as an exhibit to the Company's
Registration Statement filed on Form S-3, (No. 33-98728)Registration No. 33-98728, and
declared effective by the Securities and Exchange Commission on December
27, 1995. Confidential treatment of portions of this exhibit was granted by
the Securities and Exchange Commission pursuant to Rule 24 b-224b-2 by order
dated December 29, 1995.
(4)Incorporated by reference herein. Filed as an exhibit to the Company's
quarterly reportAnnual Report filed on Form 10K10-K with the Securities and Exchange
Commission on September 30, 1996. Confidential treatment of portions of
this documentexhibit was granted by the Securities and Exchange Commission pursuant
to Rule 24b-2 by order dated November 21, 1996.
47
(5)Incorporated by reference herein. Filed as an exhibit to the Company's
quarterly reportQuarterly Report filed on Form 10Q with the Securities and Exchange Commission
on November 14, 1996. Confidential treatment of portions of this document was
granted by the Securities and Exchange Commission pursuant to Rule 24b-2 by
order dated February 3, 1997.
(6)Incorporated by reference herein. Filed as an exhibit to the Company's
quarterly report filed on Form 10Q10-Q with the Securities and Exchange
Commission on May 2, 1997. Confidential treatment of portions of this
documentexhibit was granted by the Securities and Exchange Commission pursuant to
Rule 24b-2 by order dated June 26, 1997.
(7)(6) Incorporated by reference herein. Filed as an exhibit to the Company's
quarterly reportQuarterly Report filed on Form 10Q10-Q with the Securities and Exchange
Commission on January 30, 1998. Confidential treatment of portions of this
documentexhibit was granted by the Securities and Exchange Commission pursuant to
Rule 24b-2 by letterorder dated February 12, 1998.
(b) Reports(7) Incorporated by reference herein. Filed as an exhibit to the Company's
Quarterly Report filed on Form 8-K10-Q with the Securities and Exchange
Commission on October 30, 1998. Confidential treatment of portions of this
exhibit was granted by the Securities and Exchange Commission pursuant to
Rule 24b-2 by order dated November 23, 1998.
(8) Incorporated by reference herein. Filed as an exhibit to the Company's
Quarterly Report filed duringon Form 10-Q with the last quarterSecurities and Exchange
Commission on January 28, 1999. Confidential treatment of portions of this
exhibit was granted by the period coveredSecurities and Exchange Commission pursuant to
Rule 24b-2 by this report. None.
48order dated February 24, 1999.
(9) Incorporated by reference herein. Filed as an exhibit to the Company's
Annual Report filed on Form 10-K with the Securities and Exchange
Commission on August 19, 1998.
* Compensatory Plan
-52-
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities and
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
CREE RESEARCH, INC.
Date: August 11, 1999
By: s//s/ F. Neal Hunter
----------------------------------------------------------------------------
F. Neal Hunter
Date: August 19, 1998 President and
Chief Executive Officer
Pursuant to the requirements of the Securities and Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
s//s/ F. Neal Hunter Chairman of the Board August 19, 199811, 1999
- -----------------------------------------------------------
F. Neal Hunter
s//s/ Cynthia B. Merrell Chief Financial Officer August 19, 199811, 1999
- -----------------------------------------------------------
Cynthia B. Merrell
s//s/ Calvin H. Carter, Jr., Ph. D. Director August 19, 199811, 1999
- -----------------------------------------------------------
Calvin H. Carter, Jr., Ph.D.
s//s/ James E. Dykes
- ---------------------------- Director August 19, 1998
- -------------------------------11, 1999
James E. Dykes
s//s/ Michael W. Haley Director August 19, 199811, 1999
- -----------------------------------------------------------
Michael W. Haley
s//s/ John W. Palmour Director August 11, 1999
- ----------------------------
John W. Palmour, Ph.D
/s/ Walter L. Robb
- ---------------------------- Director August 11, 1999
Walter L. Robb, Ph.D.
Director August 19, 1998
- -------------------------------
Walter L. Robb, Ph.D.
s//s/ Dolph W. von Arx Director August 19, 199811, 1999
- -----------------------------------------------------------
Dolph W. von Arx
s/John W. Palmour, Ph.D. Director August 19, 1998
- -------------------------------
John W. Palmour, Ph.D
49-53-