UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30,DECEMBER 31, 1996
Commission file number: 0-21154
CREE RESEARCH, INC.
(Exact name of registrant as specified in its charter)
North CarolinaNORTH CAROLINA 56-1572719
(State or other jurisdiction of incorporation (IRS Employer
or organization) (IRS Employer Identification No.)
2810 Meridian Parkway, Suite 108
Durham, North CarolinaMERIDIAN PARKWAY, SUITE 144
DURHAM, NORTH CAROLINA 27713
(Address of principal executive offices)
(919)361-5709
(Registrant's telephone number)
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. [ X] Yes [ ] No
As of October 21, 1996, 12,306,858January 17, 1997, 12,310,502 shares of the registrant's common stock, par
value $0.005 per share, were outstanding.
CREE RESEARCH, INC.
FORM 10-Q
INDEX
PAGE NO.
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Page No.
Consolidated Balance Sheets at September 30,December 31, 1996 (unaudited) and
June 30, 1996 3
Consolidated Statements of Operations for the three and six months
ended September 30,December 31, 1996 and 1995 (unaudited) 4
Consolidated Statements of Cash Flows for the threesix months ended
September 30,December 31, 1996 and 1995 (unaudited) 5
Notes to Consolidated Financial Statements (unaudited) 7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 910
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 1517
Item 4. Submission of Matters to a Vote of Security Holders 17
Item 6. Exhibits and Reports on Form 8-K 1518
Signatures 1619
2
PART 1 -Part 1- FINANCIAL INFORMATION
Item 1 -1- Financial Statements
CREE RESEARCH, INC.
CONSOLIDATED BALANCE SHEETS
September 30,December 31, June 30,
1996 1996
------------ -------------
(unaudited)------------------ -------------------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 6,270,5738,686,940 $ 10,161,706
Short-term investments, held to maturity 1,788,8901,579,343 1,787,271
Accounts receivable, net 9,258,4266,318,221 6,393,394
Inventories 4,404,3194,996,845 3,226,484
Prepaid expenses and other current assets 238,129117,292 150,990
------------ ------------------------------ -------------------
Total current assets 21,960,33721,698,641 21,719,845
Long-term accounts receivable 877,797411,560 464,253
Property and equipment, net 20,811,13723,382,320 20,218,101
Patent and license rights, net 1,223,8361,265,068 1,204,738
Other assets 61,71458,297 61,714
Goodwill, net 117,358107,017 127,692
============ ============------------------ -------------------
Total assets $ 45,052,17946,922,903 $ 43,796,343
============ ============================== ===================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable, trade $ 2,067,3901,784,126 $ 2,657,0542,473,609
Deferred revenue 1,290,160 17,330
Accrued expenses 300,140 467,201733,264 633,316
------------------ -------------------
Total current liabilities 2,367,5303,807,550 3,124,255
Long-term accrued expenses 172,103 --174,470 -
------------------ -------------------
Total liabilities 2,539,6333,982,020 3,124,255
Commitments and contingencies
Shareholders' equity:equity
Common stock, $0.005 par value; 14,500,000 shares authorized; shares
issued 12,307,502 and outstanding 12,280,858 and 12,277,418,12,277,418; net of treasury shares at
September 30December 31 and June 30, 1996, 61,534respectively 61,637 61,437
Additional paid-in capital 45,389,19445,459,580 45,342,063
Accumulated deficit (2,787,679)(2,429,831) (4,693,599)
------------ ------------
42,663,049------------------ -------------------
43,091,386 40,709,901
Less: 20,000 and 10,000 shares of common stock in
treasury, at cost, respectively (150,503) (37,813)
------------ ------------------------------ -------------------
Total shareholders' equity 42,512,54642,940,883 40,672,088
------------ ------------------------------ -------------------
Total liabilitiesliablities and shareholders' equity $ 45,052,17946,922,903 $ 43,796,343
============ ============================== ===================
The accompanying notes are an integral part of the financial statements.
3
CREE RESEARCH, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Three Months Ended September 30,
------------------------------Six Months Ended
December 31, December 31,
---------------------------------- ----------------------------------
1996 1995 --------------1996 1995
---------------- ---------------- --------------- ----------------
Revenues
Product revenues,revenue, net $ 2,751,6834,560,996 $ 2,146,7961,730,962 $ 7,312,679 $ 3,877,758
Contract revenues 2,067,125 1,212,599revenue 2,297,877 1,182,818 4,365,002 2,395,417
License fee income - 1,423,160 2,614,976 --
------------ ------------1,423,160
---------------- ---------------- --------------- ----------------
Total revenues 7,433,784 3,359,395revenue 6,858,873 4,336,940 14,292,657 7,696,335
Cost of revenues 4,263,958 2,506,5005,302,689 2,928,809 9,431,515 5,355,858
Gross margin 3,169,826 852,8951,556,184 1,408,131 4,861,142 2,340,477
Operating expenses
Research and development 113,289 84,333181,131 214,069 522,552 377,853
Sales, general and administrative 1,086,405 663,668
------------ ------------1,062,945 701,163 1,969,350 1,378,364
---------------- ---------------- --------------- ----------------
Income from operations 1,970,132 104,894312,108 492,899 2,369,240 584,260
Other income (expense)
Gain (loss) on disposal of property and equipment 92,126 - (179,126) 13,533
Interest income 147,557 91,653179,378 341,921 326,935 433,574
Interest expense -- (2,858)
------------ ------------
Income(2,366) (2,620) (2,366) (5,478)
---------------- ---------------- --------------- ----------------
Earnings before income taxes 2,117,689 193,689396,994 832,200 2,514,683 1,025,889
Provision for income taxes 211,769 --
------------ ------------39,146 10,000 250,915 10,000
---------------- ---------------- --------------- ----------------
Net income $ 1,905,920357,848 $ 193,689
============ ============822,200 $ 2,263,768 $ 1,015,889
================ ================ =============== ================
Net incomeearnings per share $ 0.150.03 $ 0.02
============ ============0.07 $ 0.17 $ 0.09
================ ================ ================ ================
Weighted average shares outstanding 13,034,738 11,905,258
============ ============13,011,957 12,018,541 13,018,404 11,380,536
================= ================== ================ ================
The accompanying notes are an integral part of the financial statements.
4
CREE RESEARCH, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
ThreeSix Months Ended
September 30,
----------------------------December 31,
--------------------------------------------
1996 1995
----------- ------------------------------- -------------------
Operating activities:
Net income $ 1,905,9202,263,768 $ 193,6891,015,889
Adjustments to reconcile net income to net cash used inprovided by
(used in) operating activities:
(Gain) loss on disposal of property and equipment 179,126 (13,533)
Depreciation and amortization 737,328 302,1751,546,461 612,127
Amortization of patent rights write offs and other 42,347 29,34148,014 63,625
Amortization of goodwill 10,334 10,33420,675 20,667
Loss on write off of Eastern European Division assets 87,000 --patents 20,274 -
Non-cash compensation expense related to stock options -- 861- 1,722
Changes in assets and liabilities:
Accounts receivable (3,278,576) (439,752)75,173 (1,721,256)
Inventories (1,177,835) (398,553)(1,770,361) (657,347)
Deferred costs on research contracts --- 81,006
Prepaid expenses and other assets (87,140) (67,166)89,808 (71,772)
Accounts payable, trade (788,433) (135,395)(689,483) (157,686)
Deferred revenue 1,272,830 -
Accrued expenses 5,042 (94,406)
------------ ------------and other liabilities 274,418 (72,555)
------------------- -------------------
Net cash used inprovided by (used in) operating activities (2,544,013) (517,866)3,330,703 (899,113)
Investing activities:
MaturitiesMaturity of investment securities -- 1,996,092207,928 2,003,650
Purchases of property and equipment (1,218,596) (1,987,309)(4,889,806) (6,701,041)
Proceeds from sale of property and equipment - 50,000
Purchase of patent rights (63,063) (45,317)
------------ ------------(128,618) (115,333)
------------------- -------------------
Net cash used in investing activities (1,281,659) (36,534)(4,810,496) (4,762,724)
Financing activities:
Repurchase of common stock (112,690) ---
Net proceeds from issuance of common stock 47,229 14,753,248
------------ ------------117,717 20,746,571
------------------- -------------------
Net cash (used in) provided by financing activities (65,461) 14,753,248
------------ ------------5,027 20,746,571
------------------- -------------------
Net increase (decrease)increases (decreases) in cash and cash equivalants (3,891,133) 14,198,848(1,474,766) 15,084,734
Cash and cash equivalents:
Beginning of period 10,161,706 3,748,422
------------ ------------------------------- -------------------
End of period $ 6,270,5738,686,940 $ 17,947,270
============ ============
18,833,156
=================== ===================
The accompanying notes are an integral part of the financial statements.
5
CREE RESEARCH, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited) - (Continued)
ThreeSix Months Ended
September 30,
--------December 31,
--------------------------------------------
1996 1995
--------- ----------
------------------- -------------------
Supplemental schedule of non-cash investing and financing activities:
$198,769 $1,331,110
Accounts payable recorded for purchases of equipment $ --708,425 $ 546,480
Payable recorded1,104,065
Professional fees associated with equity transactions $ 19,000
Cash paid for placement agent commissionsinterest $ -- $6,263,350
Subscription receivable for common stock5,478
The accompanying notes are an integral part of the financial statements.
6
CREE RESEARCH, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Basis of Presentation
The balance sheet as of September 30,December 31, 1996, the statements of operations
for the three and six month periods ended September 30,December 31, 1996 and 1995, and the
statementsstatement of cash flows for the threesix months ended September 30,December 31, 1996 and 1995,
have been prepared by the Company without audit. In the opinion of management,
all adjustments necessary to present fairly the financial position, results of
operations and cash flows at September 30,December 31, 1996, and all periods presented, have
been made. The balance sheet at June 30, 1996, has been derived from the audited
financial statements as of that date.
Certain information and footnote disclosures normally included in
financial statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted. It is suggested that these condensed
financial statements be read in conjunction with the financial statements and
notes thereto included in the Company's fiscal 1996 Form 10-K. The results of
operations for the period ended September 30,December 31, 1996, are not necessarily
indicative of the operating results that may be attained for the entire fiscal
year.
Inventories
Inventories are stated at the lower of cost or market, with cost
determined under the first-in, first-out (FIFO) method. Inventories consist of
the following:
September 30,December 31, 1996 June 30, 19951996
Raw materials $1,595,071 $1,308,766$2,286,000 $1,309,000
Work-in-progress 1,253,885 947,7851,382,000 948,000
Finished goods 1,555,363 969,933
-------------1,329,000 969,000
----------- $4,404,319 $3,226,484
============= ===========------------
$4,997,000 $3,226,000
========== ==========
Loan Availability
The Company has access to a term loan financing arrangement of up to $4,000,000
to facilitate the purchase of new equipment. The provisions of the loan were
agreed to in October and the Company has up to six months from that date to
exercise this option. The loan accrues interest at 8% and carries customary
covenants, namely the maintenance of a minimum tangible net worth and cash and
investment balances. Collateral would consist of a first position lien on
equipment purchased. As of December 31, 1996, there were no outstanding
borrowings under this facility.
7
License Fee Income
On September 30, 1996, the Company entered into a license and
technology transfer agreement and a related supply agreement with Shin-Etsu
Handotai Co. Ltd. ("SEH") and other parties. Pursuant to these agreements, the
Company granted SEH a license to use certain epitaxial and device fabrication
process technology for the manufacture of the Company's super-bright blue light-emitting
diode product 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 running royalties based on a percentage of sales of products
made using the licensed technology. The license fee is payable in installments.
The first and second installments withtotaling $1,200,000 were collected during the
first installmentsecond quarter of $700,000 due upon execution of the
agreement1997, and additional $500,000 payments are due December 31, 1996,on March 31,
1997, June 30, 1997 and June 30, 1998. The Company recorded a long-term accrued
expense of $186,000 payable June 30, 1998 to the third party that brokered the
license agreement. Substantially all of the Company's obligations to transfer
the licensed technology were performed at September 30, 1996, and the net
present value of the license fee payments and commission was recognized at that
time.
Research and Development Cost Policy
The Company benefits from research and development efforts sponsored by
both government contracts and from internal corporate funding. Contracts are
awarded to the Company to fund both short term and long term research projects.
Contract revenues represent reimbursementfunding by various U.S. Government entities of
research and development costs and a portion of the Company's general and
administrative expenses either on a cost plus or a cost share basis.
TheIn accordance with the cost share provisions of the U.S. Government
contracts, the Company has incurred some direct manufacturing, and an allocated
portion of research and development and general and administrative costs, unabsorbed by
contract researchthat
are not funded, totaling $366,000 and grants totaling $113,000 and $84,000,$897,000, for the three and six month
periods ended September 30,December 31, 1996, respectively. The Company spent $188,000 and
1995, respectively.$283,000, respectively, in these same type of unfunded costs in the second
quarter and first six months of fiscal 1996.
Contract revenues from the U.S. Government contracts funded direct
manufacturing expenditures of $1,745,000 and $3,429,000, for the three and six
month periods ended December 31, 1996. Contract revenues also funded direct
expenditures of $1,576,000$826,000 and $959,000, net of cost share,$1,784,000, for the three and six month periods
ended September 30,
1996 andDecember 31, 1995. TheseThe related expenses, and their related cost sharing componentthe direct manufacturing
portion of unfunded costs (cost share amounts), are classified as a cost of
revenues.revenue.
Also included inas contract revenue is the cost of revenues is
$120,000 and $83,000 foramount received from the
three months ended September 30, 1996 and 1995,
respectively,U.S. Government for research and development overhead recovery, netand general and administrative
costs associated with the contracts. For the three and six months ended December
31, 1996,
8
the amounts reimbursed totaled $355,000 and $620,000, respectively. Comparable
amounts paid by contract funding in the prior year were $264,000 and $487,000.
The related expenses to this government funding and the unfunded portion of
cost share.costs (cost share amounts), appear as research and development and general and
administrative expenses.
Contract revenues providedrevenue also includes additional funding totaling $148,000$173,000
and $133,000
through overhead rates for other operating expenses$317,000, for the three and six month periods ended September 30,December 31, 1996, and 1995, respectively. The cost sharing component of
contract revenues totaled $531,000 and $95,000 for
the three months ended
September 30,profit element of cost-plus contracts and facilities cost of capital
reimbursement. Comparable amounts for fiscal 1996 are $23,000 and 1995,$125,000,
respectively.
Income Taxes
The Company has provided an estimated tax provision based upon an
effective rate of 10%. The estimated effective rate was based upon projections
of income for the fiscal year and the Company's ability to utilize existing net
operating loss carryforwards. However, the actual effective rate may vary
depending upon actual pre-tax book income for the year.
Reclassifications
Reclassifications of certain amounts have been made to the SeptemberJune 30,
19951996 consolidated balance sheet and the statement of operations for the three
and six months ended December 31, 1995 to conform to the fiscal 1997
presentation. These reclassifications had no effect on shareholders' equity, the
results of operations or per share data.
Subsequent EventContingencies
The Company has been named as a defendant in a purported class
action lawsuit filed October 25,December 20, 1996 in the U.S.U.S District Court for the Middle
District of North Carolina. Certain directors and officers of the Company are
also named as defendants. The plaintiff seeks to represent a class of all
persons who purchased the Company's common stock between February 1, 1996 and
July 2, 1996 (the "Class Period"). The complaint asserts claims under the
Securities Exchange Act of 1934, as well as claims of negligent
misrepresentation and common law fraud, based upon alleged material
misrepresentations and omissionomissions during the Class Period.
The claims asserted in the suit are substantially the same as those in the
complaint filed October 25, 1996 in the same court, which was described in the
Company's report on Form 10-Q filed for the period ended September 30, 1996. The
plaintiffs in the two actions have jointly moved that the actions be
consolidated. The Company believes that the allegations of the complaintboth suits are
without merit and intends to defend the suitthem vigorously.
9
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Cautionary Statement Identifying Important Factors That Could Cause the
Company's Actual Results to Differ From Those Projected in Forward
Looking Statements
In connection with the "safe harbor" provisions of the Private
Securities Litigation Reform Act of 1995, readers of this document are advised
that the document contains both statements of historical facts and forward
looking statements. Forward looking statements are subject to certain risks and
uncertainties, which could cause actual results to differ materially from those
indicated by the forward looking statements. Examples of forward looking
statements include, but are not limited to (i) projections of revenues, income
or loss, earnings per share, capital expenditures, dividends, capital structure
and other financial items, (ii) statements of the plans and objectives of the
Company or its management or Board of Directors, including the introduction of
new products, 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 document also identifies important factors which could cause
actual results to differ materially from those indicated by the forward looking
statements. These risks and uncertainties include the Company's ability to
increase production capacity and yield and to reduce product unit costs, price
competition, other actions of competitors, infringement of intellectual property
rights of the Company or others, the effects of government regulation, both
foreign and domestic, availability of U.S. government funded research contracts,
possible delays in the introduction of new products, customer acceptance of
products or services and other factors. Other risk factorsrisks are discussed under "Risk
Factors" described below.
The cautionary statements made pursuant to the Private Securities
Litigation Reform Act of 1995 above and elsewhere by the Company should not be
construed as exhaustive or as any admission regarding the adequacy of
disclosures made by the Company prior to the effective date of such Act. Forward
looking statements are beyond the ability of the Company to control and in many
cases the Company cannot predict what factors would cause actual results to
differ materially from those indicated by the forward looking statements.
Results of Operations
The Company's revenues of $7,434,000,$6,859,000 for the three month period and
$14,293,000 for the six months ended December 31, 1996, represent a 121%58% and an
86% increase over the same periodperiods in fiscal 1996.1996, respectively. Included in the
current six
10
month period, revenue is a one-time net license fee of $2,615,000. The license fee was
earned pursuant to a license and technology transfer agreement entered into
September 30, 1996 with Shin-Etsu Handotai Co. Ltd. ("SEH"). Pursuant to this
agreement, the Company granted SEH a license to use certain expitaxial and
device fabrication process technology for the manufacture of the Company's super-bright blue
light-emitting diode ("LED") product. The license fee is payable in
installments. The first and second installments withtotaling $1,200,000 were
collected in the first installment of $700,000 due upon execution of the agreementsecond quarter, and additional $500,000 payments are due December 31, 1996,on
March 31, 1997, June 30, 1997 and June 30, 1998. The Company recorded a
long-term accrued expense of $186,000 payable June 30, 1998 to the third party
that brokered the agreement. Substantially all of the Company's obligations to
transfer the licensed technology were performed at September 30, 1996, and the
net present value of the license fee payments and commission was recognized at
that time. Results for the three and six months ended December 31, 1995,
included one time net license fee revenue of $1,423,000. This license fee was
earned pursuant to a development license and supply agreement entered into
October 25, 1995 with Siemens A.G. ("Siemens") in which the Company granted
Siemens a license to use certain technology to manufacture blue LED products.
Product revenue increased 28%163% to $2,752,000$4,561,000 for the quarter ended
September 30,December 31, 1996 compared to $2,147,000$1,731,000 for the same period in fiscal 1996.
Product revenue also increased 89% to $7,313,000 for the six month period ended
December 31, 1996, compared to $3,878,000 for the same period in the previous
year. Product revenue is comprised of wafer products, LED sales, wafer and RCD'sother material sales,
module display products and Real Color Displays, Inc ("RCD") moving message sign
sales.
LED sales increased 73% to $1,204,000551% for the quarter ended September 30,December 31, 1996 as
compared to the same period in the prior year. For the six months ended December
31, 1996, LED revenue increased 223% as compared to the same period in fiscal
1996.
Capacity increases and production yield improvements enabled the
Company to significantly increase the number of LED's produced.produced and shipped during the second
quarter. The Company expects continued growth in LED product
sales asCompany's goal is to continue to increase the Company adds additional capacity to initially fill an order for a
major customer.production output of
its DH-85 chip. If the Company wereis unable to bring additional capacity on line,
in a timely manner or failedfails to continue the current trend of improving yields, the Company may be
unable to deliver LED's according to schedule or at reasonable cost levels. This
would negatively impact margins for the LED product and may cause the Company to
post negative operating results.
On September 6, 1996, the Company signed a Purchase Agreement with
Siemens, AG ("Siemens"), pursuant to which Siemens has agreed to purchase LED chips made using
the Company's gallium nitride-on-silicon carbide technology. The agreement calls
for shipments having an aggregate purchase price of approximately $6.5 million
during the fiscal year ending June 30, 1997 and additional shipments aggregating
approximately $5.5 million during the six-month period ending December 31, 1997,
although these additional shipments are subject to deferral of up to six months,
and to cancellation at Siemens' election by making cancellation payments to the
Company. The Purchase Agreement provides thatSubstantially all of the Company's supply
obligations are subject toLED sales of the
condition that it have obtained11
Company during the second quarter, and installed an
additional epitaxial reactor system not later than November 1, 1996. The
reactor, which is needed to augment existing capacity in order to meetsubstantially all of the volume required by the Siemens' agreement, is presently scheduled to be
delivered on November 18, 1996. As with other complex equipment, bringing the
reactor to an operational status is subject to inherent uncertainties. However,backlog orders
of the Company, anticipates thatare pursuant to this agreement with Siemens. Consequently, the
reactor will beCompany is reliant on Siemens for sales of its primary product and a reduction
in productive use in timesales to meetSiemens would have an adverse effect on the shipment schedule underCompany.
A primary goal of the Purchase Agreement.Company is to attract additional LED
customers who order commercial volumes of LEDs as the Company expands its
production capabilities. If the Company does
encounter delaysis unable to expand its customer base,
its revenue and earnings growth potential would be adversely impacted by its
production expansion plans.
The Company believes that lower pricing for its DH-85 product is
necessary to significantly grow market demand, although there can be no
assurance that lower prices will result in bringingincreased sales revenues to the
reactor on-line, it could redeploy another
system now used for research and development. In that event,Company. To offer lower pricing to customers, the Company's
program to developCompany must reduce unit costs
of production. The planned introduction of a conductive buffer layer product couldchip, which
is currently under development. is expected to allow for significant reductions
in the manufacturing cost of the chip. If the Company is unable to manufacture
this new chip structure, its ability to reduce costs appreciably would be
delayed, whichimpacted. This would delayprobably impact market development and growth for the
Company's efforts to reduce its LED production costs.business.
Wafer sales contributed $1,218,000 to product revenues duringincreased 88% for the quarter ended September 30,three months ending December 31,
1996, representing a 37% increase over the same period in the prior year. Year to date, wafer revenue has
grown 63%, over fiscal 1996.1996 results. Additional sales were realized as a result
of consistentgreater demand for the Company's SiC wafers and the availability of
additional crystal growth capacity as well as capacity and yield improvements toin
other wafer processing areas.
DisplayModule sales provided revenue of $545,000 and module$741,000 for the three
months and six months ended December 31, 1996. These figures compare to revenue
of $9,000 recorded in the second quarter of 1996, as this was a new business at
that time. RCD display moving message sign sales fell by 42%69% to $330,000$138,000 during
the firstsecond quarter of fiscal 1997 as compared to the firstsecond quarter of fiscal
1996. The
declineFor the six months ended December 31, 1996, RCD display sign sales were
$272,000 compared to $1,006,000 recorded in the prior year. This significant
reduction in revenue is mainly attributable to a shortagedeclining interest from our
customer base, as moving message signs are no longer "newer" technology.
Customers are now more interested in specific purpose static signs. The make up
of quality piece parts thatcustomers is also changing from small dealers and distributors to equipment
manufacturers. As a result of these changes, the Company purchases from a vendor. Issues relatingcontinues to quality supplies have been
resolvedfocus
increasing sales efforts on the module line of business.
Research contract revenues increased 94% to $2,298,000 for the three
month period, and 82% to $4,365,000 for the six month period ended December 31,
1996, as compared to fiscal 1996 results, respectively. This increase is mainly
attributable to management's commitment, and the Company expectsU.S. Government's partnering
with new funding contracts, to realize improved sales levelsthe advancement of silicon carbide and gallium
nitride technology, primarily
12
in blue laser, microwave and material development. Other silicon carbide
projects are also targeted.
The Company's gross margin was 23% and 34% for the three and six months
ended December 31, 1996, respectively. This compares to 32% and 30% for the same
time periods in fiscal 1996, respectively. License fee revenue is included in
both six month periods and the prior year second quarter gross margins. There
was no license fee revenue recorded in the second quarter of fiscal 1997. Contract revenues increased 71% to 2,067,000 for the three months
ended September, 30, 1996, as compared to the three months ended September 30,
1995. The increase is mainly attributable to an increased contract backlog and
greater resource allocation to contract efforts.
The Company's gross margin increased to 43% for the three month
period ended September 30, 1996, compared to 25% for the same period in fiscal
1996. This increase was caused solely by theWithout
license fee income recognized in
the current period. Without the license fee incomefees, gross margins would have been $555,000$2,246,000 or 12%19% for the current
threesix month period a decrease from 25% inended December 31, 1996, and (.5)% and 15%, respectively, for
the three months ended September 30, 1995.and six month comparative periods in fiscal 1996. The decreaseoverall increase
in gross margin, as
adjusted,margins, net of license fee revenue, results from higher throughput and yield
efficiency on LED and materials products, which is mainly attributable to increasedlowering the cost sharing on government
contracts which increased from 8% of contract revenue to 26% of contract
revenues and to a decline in margin on RCD's products.per unit.
The Company benefits from research and development efforts sponsored by
both U.S. Government contracts and from internal corporate funding. Contracts
are awarded to the Company to fund both short term and long term research
projects. Contract revenues represent reimbursementfunding by various government entities for
research and development costs and a portion of the Company's general and
administrative expenses either on a cost plus or a cost share basis. Funding for
projects with near term applications for the Company typically include a cost
share component that the Company is responsible for absorbing as
a cost of revenues.absorbing. 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 of 7% to 10%.
Contract revenues funded direct expenditures of $1,576,000 and
$959,000, net of cost share, for the three month periods ended September 30,
1996 and 1995. These expenses and their related cost sharing component are
classifiedFor financial statement purposes, costs associated with government
contract research, appear as a cost of revenues. Also included in the cost of revenues is
$120,000 and $83,000 for the three months ended September 30, 1996 and 1995,
respectively, fordirect manufacturing
portion (including the cost share component), research and development overhead recovery, net of cost share.
Contract revenues provided additional funding totaling $148,000for
indirect labor and $133,000
through overhead rates for other operatingrelated costs and general and administrative expenses for
overhead costs. For the three month periods
ended September 30, 1996 and 1995, respectively. The cost sharing component of
contract revenues totaled $531,000 and $95,000 for the threesix months ended September 30,December 31, 1996, and 1995, respectively.
The Company incurred research and
development costs unabsorbed by
contract revenues totaling $113,000 and $84,000,include a one time write off of $93,000 for the three month periods
ended September 30, 1996 and 1995, respectively.
Sales, general and administrative expenses increased by 64% to
$1,086,000 for the three month period ending September 30, 1996 compared to the
same period in fiscal 1996, respectively. The increase is attributable to a
$172,000 selling expense related to the license fee income and to a lossclosure of
$180,000 for estimated expenses related to closing the
Company's Eastern European Division. The Eastern European Division was a basic
research division for some of the Company's material and device development
work. The Company has decided to focus all of its research and development
efforts at its domestic locations.
Sales, general and administrative expenses increased by 52% to
$1,063,000 and 43% to $1,969,000 for the three and six month periods ending
December 31, 1996, compared to the same period in fiscal 1996, respectively. For
the quarter, the increase is attributable to overall cost increases to support
the growth of the Company and greater legal fees associated with the defense of
the pending securities class action lawsuit (see Part II, Item 1). Year to date,
expenditures are ahead of the prior year due to a combination of the net present
value of the $186,000 brokerage fee ($172,000) associated with the license fee
revenue recorded in the first quarter, and other cost increases to support the
growth of the business. The Company expects sales, general and administrative
expenses to increasecontinue to rise in future periods, as expenses are incurredit anticipates increasing
13
its marketing efforts to defend against a lawsuit recently commenced againstfind new customers for the Company. See Part II, Item 1.
Interest income increased from $92,000 to $148,000 forblue LED product, and
heavier costs in connection with the defense of the above mentioned legal
action.
During the three months ended September 30, 1996.December 31, 1996, the Company
retired two research oriented silicon carbide epitaxial reactors that will be
used in the future for spare parts. The increasetotal write-off related to this
retirement was $92,000. During the first quarter of 1997, the Company also
retired equipment associated with the closing of the Eastern European Division.
The total write off of this equipment was $87,000.
Interest income decreased $163,000 and $107,000, when comparing the
three and six month periods ending December 31, 1996 to the three and six month
periods ending December 31, 1995. This decrease is attributable to higherlower
investable cash balances available throughout the current three month period asperiods. The Company
concluded a result of the Company'sprivate equity placement in September, 1995, private equity placement.that increased
available cash in fiscal 1996. Much of this cash has now been invested in plant
and equipment.
Liquidity and Capital Resources
The Company's cash and current investment balance was $8,059,000$10,266,000 at
September 30,December 31, 1996 and $11,949,000 at June 30, 1996. For the first threesix months of
fiscal 1997, the Company's operations utilized $2,544,000.generated $3,331,000 in cash. Funds
employed in operations were used mainly to fund increasing receivables and inventory balances
and decreasing trade payables relating to operating activities. For the same
period in fiscal 1996, $518,000$899,000 was utilized by operations.
TheDuring the quarter, the Company has historically experienced days sales outstanding
higher thanfocused on reducing the general industry. Foramount of trade
accounts receivable outstanding. During the three month periodmonths ended September 30,December 31,
1996, the Company's average days sales outstanding was 118 days compared to 102
days for the same period the previous year. For the benefit of isolating
operating activity, all amounts relating to license fee agreements have been
omitted from this calculation. The high days sales outstanding is primarily due
to the timing of production and sales cycles which have generally resulted in a
significant portion of product revenue being recognized and invoiced in the
extreme later part of each quarter. Additionally, the Company has historically
invoiced government contract revenues in the period following the period in
which the revenue was recognized.accounts receivable balances were reduced by $2,940,000.
The Company invested $1,219,000 for$4,890,000 in capital equipment during the first
threesix months of fiscal 1997 compared to $1,987,000$6,701,000 in the prior year. Although
significant expansion and reconfiguration of allmany production areas has occurred
within the last fifteeneighteen months, substantial additional increases in funding
will be required to further expand the Company's production capacity to meet
current orders.orders and enhance productivity. It is anticipated that capital spending will
remain elevated over the next six months and that the Company will spend
approximately $3$5 million to $4$6 million for such capital investments.investments primarily in the
crystal growth, epitaxial and clean room areas. The Company expects to finance
these expenditures with cash generated from operations, current available cash
and a $4 million in term debt.loan. On October 17, 1996, the Company obtained a
commitment letter from a bank for this funding.term loan. As of December 31, 1996, there
were no outstanding borrowings under this facility.
During the current six month period, the Company repurchased 10,000
shares of common stock for the treasury for $113,000, net ofand issued shares issued under
option agreements for $47,000,$118,000, resulting in a net useincrease of $65,000$5,000 for
financing activities. The majority of
14
the prior period's funding was provided by the Company's September 28, 1995,
private placement which netted the Company approximately $17.5 million. $14.8 million of this funding wasand funds
received by the
Company in the quarter that ended September 30, 1995connection with the remaining $2.7
million being received the first few days of the next quarter.option exercises.
The Company expects to continue to finance its operations and capital
expenditures, including those of Real Color Displays, using internally generated funds and from the proceeds from the
term debt facility. However, the Company is always evaluatingcontinually evaluates competitive
conditions in the industry and as a part of its ongoing strategy, may seek
additional funding sources as market conditions permit.
Risk Factors
Ownership of the Company's common stock is subject to a number of
risks, including the following:
Since the Company's inception, the Company has derived approximately
half of its revenues from sales of products and the other half from funded
research contracts. Over the same period, the Company estimates that
approximately a third of its product sales have been made to customers for
commercial applications with the balance being sold for evaluationresearch purposes. A
number of customers are still evaluating the long term usefulness of the blue
LED, and on-going sales of significant volumes of products to these customers
cannot be assured. There can also be no assurance that competitors will not
introduce products that are competitive with or superior to the Company's blue
LED.
The Company periodically has experienced lower than anticipated
production yields. Production yield problems in the future could have an adverse
effect on the Company's operations. The Company manufactures several key
components used in its crystal growth and expitaxial deposition processes and
also depends, substantially, on its custom-manufactured processing equipment and
systems. Should 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 and reduce unit costs to desired levels
could be materially impacted. The Company is also dependent on single or limited
source suppliers for a number of raw materials and components used in its SiC
wafer products and LED's. An interruption in the supply of these items could
cause the Company's manufacturing efforts to be hampered significantly and
result in customer dissatisfaction.
The Company relies on a small number of customers for the majority of
its sales and thepresently is almost solely reliant on a supply agreement with
Siemens A.G. as a customer for its DH-85 blue LED chip. The loss of any one of
these customers could have a material adverse effect on the business and
prospects of the Company. The Company has, and is expected to continue to have,
a substantial percentage of its sales fromto foreign companies, primarily in Japan,
Korea, Taiwan, China 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 enforceable in the United States. In addition, the
15
Company's international sales may be subject to government controls and other
risks, including export licenses, federal restrictions on the export of
technology, changes in demand resulting from currency fluctuations, political
instability, trade restrictions, changes in tariffs, and difficulties managing
international operations and collecting accounts receivable.
The patents and other proprietary rights of the Company may not
prevent the competitors of the Company from developing noninfringing technology
and products that are more attractive to customers than the technology and
products of the Company. The technology and products of the Company could be
determined to infringe the patents or other proprietary rights of others.
To remain competitive, the Company must continue to invest substantial
resources in research and development. The Company's prospects for long-term
success are substantially dependent on its ability to continue increasing the
performance of its blue LED product. The ability of the Company
to compete effectively depends upon its ability to attract and retain
highly-skilled engineering, scientific, manufacturing, marketing and managerial
personnel.
The Company has expanded its operations rapidly and operating
results will be adversely affected if net sales do not increase sufficiently to
compensate for the increase in operating expenses caused by this expansion.
Over the last several years, the Company has been awarded 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, however, and 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 revenues. 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 or arrangements that can be expected to inure to the Company.
Cutbacks 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.
The Company is subject to a variety of government regulations
pertaining to discharges and other aspects of its manufacturing process. The
Company believes that it is currently in full compliance with such regulations;
however, any failure, whether intentional or inadvertent, to comply with such
regulations could have an adverse effect on the Company's business.
The market price of the Company's securities has been very volatile
as a result of many factors, some of which are outside the control of the
Company, including, but not limited to, quarterly variations in financial
results, announcements by the Company, its competitors, customers, potential
customers or government agencies and predictions by industry analysts, as well
as general economic conditions. Sales by the Company's existing stockholders,
trading by short sellers and other market factors may adversely affect the
market price of the Company's securities. Any or all of these risks could have a
material adverse affect on the market price of the securities of the Company.
The Company's quarterly operating results have varied significantly
as a result of a number of factors, including the timing and market acceptance
of new product introductions by the Company, the timing of significant orders
from and shipments to customers, non-recurring license fee income, and general
domestic and international economic conditions. The Company's operating results
may fluctuate in the future as a result of these and other factors, including
the Company's success in developing, introducing, and shipping new products, its
product mix, and the level of competition that it experiences.16
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
The Company has been named as a defendant in a purported class action
lawsuit filed October 25,December 20, 1996 in the U.S. District Court for the Middle
District of North Carolina. Certain directors and officers of the Company are
also named as defendants. The plaintiff seeks to represent a class of all
persons who purchased the Company's common stock between February 1, 9961996 and
July 2, 1996 (the "Class Period"). The complaint asserts claims under the
Securities Exchange Act of 1934, as well as claims of negligent
misrepresentation and common law fraud, based upon alleged material
misrepresentations and omissionomissions during the Class Period.
The claims asserted in the suit are substantially the same as those
in the complaint filed October 25, 1996 in the same court, which was described
in the Company's report on Form 10-Q filed for the period ended September 30,
1996. The plaintiffs in the two actions have jointly moved that the actions be
consolidated. The Company believes that the allegations of the complaintboth suits are
without merit and intends to defend the suitthem vigorously.
Item 6. Exhibits and Reports4. Submission of Matters to a Vote of Security Holders
The Company's Annual Meeting of Shareholders convened on Form 8-K
(a) Exhibits:
Exhibit 10.54: License and Technology Transfer
Agreement betweenNovember
12, 1996. The meeting was held at Cree Research, Inc. located at 2810 Meridian
Parkway, Durham, North Carolina. At the meeting there were 10,243,415 shares of
common stock of the Company present in person and Shin-Etsu Handotai Co. Ltd., dated September
30, 1996. Confidential treatment of this Exhibit is being requested pursuant to
Rule 24 b-2.
Exhibit 10.55: Supply Agreement between the Company and
Shin-Etsu Handotai Co. Ltd. andSummitomo Corporation, dated September 30, 1996.
Confidential treatment of this Exhibit is being requested pursuant to Rule 24
b-2.
Exhibit 11: Computation of Earnings per Share
(b) Reports on Form 8-K:
None.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d)by proxy representing, a
quorum of the Securities12,300,858 common stock shares outstanding and Exchange Actentitled to vote as
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: November 14,September 23, 1996 /s/ Alan J. Robertson
--------------------
Alan J. Robertson, CFOrecord date.
The following proposals were introduced and Secretary
Date: Novermber 14, 1996 /s/voted upon:
PROPOSAL NO.1
Election of Directors
Vote Percent of Votes Percent of
Names For Votes Cast Withheld Votes Cast
F. Neal Hunter ------------------------10,160,697 99.19% 82,718 .81%
Calvin H. Carter, Jr 10,160,697 99.19% 82,718 .81%
Walter L. Robb 10,160,697 99.19% 82,718 .81%
Michael W. Haley 10,160,297 99.19% 83,118 .81%
Dolph W. von Arx 10,160,297 99.19% 83,118 .81%
James E. Dykes 10,147,363 99.06% 96,052 .94%
John W. Palmour 10,160,697 99.19% 82,718 .81%
17
Percentage of
Percent of Shares
Votes Cast Outstanding
PROPOSAL NO.2
Amended and Restated Equity Compensation Plan
8,687,841 votes were cast FOR 92.6% 70.6%
600,823 votes were cast AGAINST 6.4% 4.9%
96,063 votes were ABSTAINED 1.0% .8%
TOTAL VOTES CAST 9,384,727
PROPOSAL NO. 3
Retaining Current Auditors
9,988,110 votes were cast FOR 97.5% 81.2%
29,949 votes were cast AGAINST .3% .2%
225,356 votes were ABSTAINED 2.2% 1.8%
TOTAL VOTES CAST 10,243,415
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
Exhibit 11: Computation of Earnings per Share
(b) Reports on Form 8-K:
None.
18
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: February 4, 1997 /s/Alan J. Robertson
---------------- ---------------------------
Alan J. Robertson, Chief
Financial Officer and
Secretary
Date: February 4, 1997 /s/F. Neal Hunter
---------------- ---------------------------
F. Neal Hunter, President and
Chief Executive Officer
21