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