UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR
15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 29,September 27, 1998
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ____________ to _______________
Commission file number: 0-21154
CREE RESEARCH, INC.
(Exact name of registrant as specified in its charter)
North Carolina 56-1572719
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
4600 Silicon Drive, Durham, NC 27703
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (919) 361-5709
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][X] Yes [ ] No
The number of shares outstanding of the registrant's common stock, par value
$0.005 per share, as of April 17,October 20, 1998 was 13,046,421.12,777,138.
CREE RESEARCH, INC.
FORM 10-Q
For the Quarter Ended March 29,September 27, 1998
INDEX
Page No.
--------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets at March 29,September 27, 1998 (unaudited) and
June 30, 199728, 1998 3
Consolidated Statements of Income for the three and nine months ended March 29,September
27, 1998 and March 31,September 28, 1997 (unaudited) 4
Consolidated Statements of Cash Flows for the ninethree months ended
March 29,September 27, 1998 and March 31,September 28, 1997 (unaudited) 5
Notes to Consolidated Financial Statements (unaudited) 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 12
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 1716
Signatures 18
2
PART 1- FINANCIAL INFORMATION
Item 1- Financial Statements
CREE RESEARCH, INC.
CONSOLIDATED BALANCE SHEETS
(in 000's except per share amounts)
March 29,September 27, June 30,28,
1998 19971998
-------------- -----------------------------
ASSETS (Unaudited)
Current assets:
Current assets:
Cash and cash equivalents $17,633 $10,448
Short term investments (trading security) 746 -$13,036 $17,680
Marketable securities 824 657
Accounts receivable, net 7,979 7,69411,696 10,479
Inventories 2,577 3,9493,249 2,543
Deferred income tax 1,830 1,8301,951 1,952
Prepaid expenses and other current assets 668 466754 1,347
-------------- -----------------------------
Total current assets 31,433 24,387
Long-term accounts receivable 55 5431,510 34,658
Property and equipment, net 31,790 24,33340,668 36,476
Patent and license rights, net 1,457 1,2671,568 1,525
Other assets 9 9664 65
-------------- -----------------------------
Total assets $64,744 $50,137$73,810 $72,724
============== =============================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable, trade $3,572 $2,248$4,969 $5,595
Current maturities of long term debt 69 17
Accrued salaries and wages 631 292718 391
Other accrued expenses 2,411 8341,794 1,052
-------------- -----------------------------
Total current liabilities 6,614 3,3747,550 7,055
-------------- -----------------------------
Long term liabilities:
Long-term debt 4,378 -
Non-current deferred9,931 8,650
Deferred income tax 1,638 1,6382,153 2,154
-------------- -----------------------------
Total long term liabilities 6,016 1,63812,084 10,804
-------------- -----------------------------
Shareholders' equity:
Preferred stock, par value $0.01; 2,750
shares authorized; none issued and
outstanding - -
Common stock, $0.005 par value; 14,500 shares
authorized; shares issued and outstanding
13,046,12,776, and 12,523,12,989, at March 29,September 27, 1998, and
June 30, 1997,28, 1998, respectively 64 65 62
Additional paid-in-capital 48,804 46,21446,622 49,676
Retained earnings (accumulated deficit) 3,245 (1,151)7,490 5,124
-------------- -----------------------------
Total shareholders' equity 52,114 45,12554,176 54,865
-------------- -----------------------------
Total liabilities and shareholders' equity $64,744 $50,137$73,810 $72,724
============== =============================
The accompanying notes are an integral part of the consolidated financial
statements.
3
CREE RESEARCH, INC.
CONSOLIDATED STATEMENTS OF INCOME
(in 000's except per share amounts)
(Unaudited)
Three Months Ended
Nine Months Ended
---------------------------- -----------------------------
March 29, March 31, March 29, March 31,--------------------------------------------------------
September 27, September 28,
1998 1997
1998 1997
------------- ------------- ------------ -------------------------------- ----------------------
Revenue:
Revenue:
Product revenue, net $8,929 $5,571 $25,298 $12,883$10,720 $8,206
Contract revenue, net 1,742 1,395 5,685 4,996
License fee income - - - 2,615
------------- ------------- ------------ -------------1,559 2,001
------------------- --------------------
Total revenue 10,671 6,966 30,983 20,494
------------- ------------- ------------ -------------12,279 10,207
------------------- --------------------
Cost of revenue:
Product revenue 5,510 3,488 15,875 8,6975,415 5,419
Contract revenue 1,430 1,244 4,679 4,462
------------- ------------- ------------ -------------1,207 1,653
------------------- --------------------
Total cost of revenue 6,940 4,732 20,554 13,159
------------- ------------- ------------ -------------6,622 7,072
------------------- --------------------
Gross margin 3,731 2,234 10,429 7,3355,657 3,135
Operating expenses:
Research and development net 367 485 1,287 1,247806 394
Sales, general and administrative 1,041 1,079 3,026 3,0491,218 1,140
Other (income) expense 31 204 423 383
------------- ------------- ------------ -------------269 (6)
------------------- --------------------
Income from operations 2,292 466 5,693 2,6563,364 1,607
Interest income, net 180 138 513 462
------------- ------------- ------------ -------------115 164
------------------- --------------------
Income before income taxes 2,472 604 6,206 3,1183,479 1,771
Income tax expense 717 50 1,810 300
------------- ------------- ------------ -------------1,113 602
------------------- --------------------
Net income $1,755 $554 $4,396 $2,818
============= ============= ============ =============2,366 $1,169
=================== ====================
Basic earnings per common share $0.13 $0.04 $0.34 $0.23
============= ============= ============ =============$0.18 $0.09
=================== ====================
Diluted earnings per common share $0.13 $0.04 $0.33 $0.22
============= ============= ============ =============$0.18 $0.09
------------------- --------------------
The accompanying notes are an integral part of the consolidated financial
statements.
4
CREE RESEARCH, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in 000's except per share amounts)
(Unaudited)
NineThree Months Ended
-----------------------------------
March 29, March 31,----------------------------------------------------
September 27, September 28,
1998 1997
------------- ---------------------------------------- -----------------
Operating activities:
Operating activities:
Net income $4,396 $2,818$2,366 $1,169
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 3,125 2,4141,140 1,017
Loss on disposal of property, equipment and equipment 326 386
Loss on write off of patents - 129511 294
Amoritization of patent rights 75 7928 25
Amortization and write off of goodwill 86 310 10
Purchase of marketable trading security (1,500) -
Proceeds from sale of marketable trading security 421(234) -
Loss on marketable trading security 33367 -
Changes in assets and liablilties:
Accounts receivable (286) (592)(1,217) (871)
Inventories 1,373 (1,761)(706) 735
Prepaid expenses and other assets (201) (502)595 48
Accounts payable, trade (699) (1,143)
Deferred revenue (2) (17)(2,452) (850)
Accrued expenses 1,915 730
------------- -------------1,119 890
------------------- ------------------
Net cash provided by operating activities 9,362 2,5721,217 2,467
Investing activities:
Maturity of investment securities - 1,787
Purchases of property and equipment (9,346) (6,329)(4,006) (775)
Proceeds from sale of property and equipment 463 1810 35
Purchase of patent rights (265) (188)
------------- -------------(91) (82)
------------------- ------------------
Net cash used in investing activities (9,148) (4,712)(4,087) (822)
Financing activities:
Proceeds from issuance of long-term debt 4,3781,281 -
Net proceeds from issuance of common stock 2,911 431159 826
Repurchase of common stock (318) (113)
------------- -------------(3,214) -
------------------- ------------------
Net cash (used in) provided by financing activities 6,971 318(1,774) 826
Net (decrease) increase (decrease) in cash and cash equivalents 7,185 (1,822)
============= =============(4,644) 2,471
=================== ==================
Cash and cash equivalents:
Beginning of period 17,680 10,448
10,162
============= ================================ ==================
End of period $17,633 $8,340
============= =============$13,036 $12,919
=================== ==================
Supplemental disclosure of cash flow information:
Cash paid for interest, net amounts capitalized $ 112 $ -
=================== ==================
Cash paid for income taxes $ 164 $ 81
=================== ==================
The accompanying notes are an integral part of the consolidated financial
statements.
5
Cree Research, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Basis of Presentation
The balance sheet as of March 29,September 27, 1998, the statements of operationsincome for
the three and nine month periods ended March 29,September 27, 1998 and March 31,September 28, 1997, and the
statements of cash flows for the ninethree months ended March 29,September 27, 1998 and
March 31,September 28, 1997 have been prepared by the Company and have not been audited.
In the opinion of management, all adjustments necessary to present fairly the
financial position, results of operations and cash flows at March 29,September 27, 1998,
and all periods presented, have been made. The balance sheet at June 30, 199728, 1998
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 19971998 Form 10-K. The results of
operations for the period ended March 29,September 27, 1998 are not necessarily
indicative of the operating results that may be attained for the entire fiscal
year.
Accounting Policies
Change in Fiscal Year
On September 24, 1997, the Board of Directors of Cree Research, Inc.
changed theThe Company's fiscal year from the twelve months ending June 30 tois a 52 or 53-week year53 week period ending on the last
Sunday in the month of June. Accordingly, all quarterly reporting will reflectreflects a 13
week period in fiscal 1999. In fiscal 1998, the Company changed its fiscal year
from the twelve months ending June 30, to the 52 week period ending on the last
Sunday in the month of June. Accordingly, all quarterly reporting for that year
reflected a 13 week period, except that the period ended September 28, 1997,
which commenced July 1, 1997, reflectsreflected the results of twelve weeks and five
days. The Company's current fiscal year will extend from July 1, 1997June 29, 1998 to June
28, 1998.27, 1999.
6
Investments
Investments are accounted for in accordance with Statement of Financial
Accounting Standards No. 115 (SFAS No. 115) "Accounting for Certain Investments
in Debt and Equity Securities". This statement requires certain securities to
be classified into three categories:
6
(a) Securities Held-to-Maturity- Debt securities that the entity has the
positive intent and ability to hold to maturity are reported at
amortized cost.
(b) Trading Securities- Debt and equity securities that are bought and held
principally for the purpose of selling in the near term are reported at
fair value, with unrealized gains and losses included in earnings.
(c) Securities Available-for-Sale- Debt and equity securities not
classified as either securities held-to-maturity or trading securities
are reported at fair value with unrealized gains and losses excluded
from earnings and reported as a separate component of stockholders'
equity.
The Company's short-term investments are comprised of equity securities
that are classified as trading securities, which are carried at their fair value
based upon quoted market prices of those investments at March 29,September 27, 1998, with
net realized and unrealized gains and losses included in net earnings.
As of March 29,September 27, 1998, short-term investments consist of common stock
holdings in C3, Inc. ("C3"), a portionthe majority of which were purchased in November
1997.1997 and September 1998. The Company's president has, through a binding
agreement, promised to indemnify the Company for losses of up to $300,000 in$450,000 for
the net difference between the aggregate cash consideration paid by Cree for the
shares of C3 common stock and the cash proceeds received by Cree upon the sale
of C3 common shares. This indemnity covers losses that may result from the sale
of shares purchased in November 1997 and September 1998 below the purchase price
paid.paid, offset by gains realized on shares acquired directly from C3 in January
1997 (see below). Payment of this obligation is due within ten days after
receipt by the president of the Company's written demand made pursuant to a vote
of the majority of the members of the Board of Directors other than the
president. At March 29,September 27, 1998, the Company had recorded a $300,000$450,000 receivable
from the president (included in net accounts receivable) based upon this
agreement.agreement for the net realized and unrealized losses on this investment.
Realized losses on shares of C3 stock sold by the Company during fiscal 1998
totaled $254,000, and net unrealized losses offset by the unrealized gain on
shares acquired from C3 directly (see below) were $233,000 at September 27,
1998. Approximately $5,000 of losses on the investment in C3 stock is included
in other income (expense) for fiscal 1999.
In addition to the shares of C3 purchased in November 1997 and September
1998, the Company acquired 24,601 shares of C3 common stock in January 1997.
These shares
7
were issued pursuant to an option C3 granted to the Company in 1995. The option
gave the Company the right to acquire, for an aggregate consideration of $500,
one percent of the outstanding common stock of C3. C3 retained the right to
waive the consideration and issue the stock at any time, which it elected to do
in January 1997. The shares issued pursuant to the option are restricted
securities within the meaning of Rule 144 under the Securities Act of 1933,
which permits the sale of such securities without registration if certain
conditions are met. The shares first become eligible for sale under Rule 144 in
the third quarter of fiscal 1998, at which time the Company recorded a one-time gain of $217,000 to
reflect these shares on its books at market value. A net $33,000 loss was
recorded in the third quarter to reflect total investment activity.
Significant Property Acquisition
In November 1997, the Company purchased real property consisting of
approximately thirty acres of land with a production facility of approximately
145,000 square feet and a total of approximately 35,000 square feet of service
and warehouse buildings. This property is located in Durham, North Carolina, in
the vicinity of the Research Triangle Park. The purchase price of the land and
buildings was $3,000,000.
7
The Company moved most of its sales and administrative personnel to this
facility in January 1998.
The Company anticipates it will relocate its other
operations to this facility over the next few quarters. The Company expects that
the relocation will be completed during fiscal 1999.Long Term Debt
The Company obtained a term loan from a commercial bank of up to
$10,000,000 to finance the purchase and upfit of the facility. Approximately
$2,950,000 was disbursed under the loana production facility and
service and warehouse buildings in November 1997 to finance1997. As of September 27, 1998 the
purchase,entire $10,000,000 loan was outstanding, including a current portion of $69,000
and additional proceeds under the loan are distributed to the Company
on a monthly basis based on actual expenditures incurred. Draws under the loan
agreement may be made only during an eighteen month period ending in May 1999.long term amount of $9,931,000. The loan, which is collateralized by the
purchased property, accrues interest at a fixed rate of 8% and carries customary
covenants, including the maintenance of a minimum tangible net worth and other
requirements. Accrued interest is due monthly until May 1999, at which time the
outstanding principal balance will be amortized over twenty years until 2011,
when the loan balance becomes due.
At
March 29, 1998, long term borrowings associated with this loan were $4,378,000
leaving $5,622,000 unused and available.
During the three and nine months ended March 29,September 27, 1998, the Company capitalized
interest on funds used to construct property, plant and equipment in connection
with the newly acquired facility. Interest capitalized for the three and nine months ended March 29,September 27,
1998, was $24,000 and $38,000, respectively.
Goodwill
Goodwill shown on the statements represents the amount by which the
costs to acquire the net assets of the Real Color Displays subsidiary exceeded
their related fair value at acquisition. Based on a review of undiscounted cash
flows of the subsidiary anticipated over the remaining amortization period, the
Company determined that goodwill had been impaired. As a result, the Company
recorded a charge to eliminate the $66,000 net book value in the second quarter
of fiscal 1998. As required by generally accepted accounting principles, this
write-off, which was considered a change in accounting estimate, was included in
the results of operations.$84,000.
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:
8
March 29,September 27, 1998 June 30, 199728, 1998
(in 000's) (in 000's)
---------- ----------
Raw materials $1,025 $1,559$1,190 $ 999
Work-in-progress 591 1,3741,157 752
Finished goods 961 1,016902 792
------ ------
Total Inventory $2,577 $3,949$3,249 $2,543
------ ------
8
Research and Development Accounting Policy
The U.S. Government provides funding for several of the Company's current
research and development efforts. The contract funding may be based on a
cost-plus or a cost-share arrangement. The amount of funding under each contract
is determined based on cost estimates that include direct costs, plus an
allocation for research and development, general and administrative and cost of
capital expenses. Cost-plus funding is determined based on actual costs plus a
set percentage margin. For cost-share contracts, the actual costs are divided
between the U.S. Government and the Company based on the terms of the contract.
The government's cost share is then paid to the Company. Activities performed
under these arrangements include research regarding silicon carbide and gallium
nitride materials. The contracts typically require submission of a written
report to document the results of such research.
The revenue and expense classification for contract activity is determined
based on the nature of the contract. For contracts where the Company anticipates
that funding will exceed direct costs over the life of the contract, funding is
reported as contract revenue and all direct costs are reported as costs of
contract revenue. For contracts under which the Company anticipates that direct
costs will exceed amounts to be funded over the life of the contract, costs are
reported as research and development expenses and related funding as an offset
of those expenses. The following table details information about contracts for
which direct expenses exceed funding by period as included in research and
development expenses:
Three months ended (in 000's)
Nine months ended (in 000's)
----------------------------- ----------------------------
March 29, March 31, March 29, March 31,September 27, September 28,
1998 1997
1998 1997
------------ --------- --------- -------------------- ----------
Net R&D costs $ - $ 223 $281 $ 432120
Government funding - 663 598 1,427
-----------287
------ ---- ------
Total direct costs incurred $ - $ 886 $879 $1,859407
------ ------
As of March 29,September 27, 1998, all funding under contracts where the Company
anticipates that direct costs will exceed amounts to be funded has been
exhausted. Therefore, the Company anticipates that all future funding under
existing contracts will be reflected as contract revenue while direct costs will
be reported as contract cost of sales.
9
Significant Sales Contract
In September 1996, the Company entered into a Purchase Agreement with
Siemens AG ("Siemens"), pursuant to which Siemens agreed to purchase LED chips
made with the Company's gallium nitride-on-silicon carbide technology. In April
1997 aand December 1997, contract amendment wasamendments were executed that provided for
enhanced product specifications requested by Siemens.Siemens and larger volume
requirements, respectively.
In December 1997,September 1998, the Company and Siemens further amended the contract to
extend the Purchase Agreement with respect to shipments of blue light emitting diodes to Siemens through calendarbe made on or after
June 29,
9
1998. The secondthird amendment obligates the Company to ship, and Siemens to
purchase, stipulated quantities of both the conductive buffer and the new high
brightness LED chip. Thesechips and silicon carbide wafers through fiscal 1999. The
agreement also limits Siemen's right to defer shipments are expected to provide revenue30% of scheduled
quantities for items to be shipped in excessmore than 24 weeks after initial notice
and 10% of $3.4 millionscheduled quantities for the remainderitems to be shipped in more than 12 weeks.
In both cases, Siemens would be required to accept all product within 90 days of
the 1998 fiscal
year. Additional shipments anticipatedoriginal shipment date. Additionally, the amendment provides for fiscal 1999 are subjecthigher per
unit prices early in the contract with reductions in unit prices being available
as the cumulative volume shipped increases. The higher prices were negotiated by
the Company to certain
rescheduling and cancellation provisions.offset higher per unit costs expected earlier in the contract.
Income Taxes
The Company has established an estimated tax provision based upon an
effective rate of 29%32%. The estimated effective rate was based upon projections
of income for the fiscal year and the Company's ability to utilize remaining net
operating loss carryforwards and other tax credits. However, the actual
effective rate may vary depending upon actual pre-tax book income for the year
or other factors.
Earnings Per Share
The Company has adoptedpresents earnings per share in accordance with Statement
of Financial Accounting Standards (SFAS) No. 128, "Earnings Per Share", as of December 28, 1997.. SFAS No.
128 required the Company to change its method of computing, presenting and
disclosing earnings per share information. All prior period data presented has
been restated to conform to the provisions of SFAS No. 128.
10
The following computation reconciles the differences between the basic and
diluted presentations:
Three Months Ended Nine Months Ended
--------------------------------- ---------------------------------
March 29, March 31, March 29, March 31,
1998 1997 1998 1997
(in 000's, (in 000's, (in 000's, (in 000's,
except per except per except per except per
share amounts) share amounts) share amounts) share amounts)
--------------- ---------------- ---------------- ----------------
Net income $1,755 $554 $4,396 $2,818
Weighted average common shares 13,028 12,326 12,808 12,300
--------------- ---------------- ---------------- ----------------
Basic earnings per common share $0.13 $0.04 $0.34 $0.23
=============== ================ ================ ================
Net income $1,755 $554 $4,396 $2,818
Weighted average common shares:
Common shares outstanding 13,028 12,326 12,808 12,300
Dilutive effect of stock options & 473 730 707 731
warrants
--------------- ---------------- ---------------- ----------------
Total weighted average common shares 13,501 13,056 13,515 13,031
Diluted earnings per common share $0.13 $0.04 $0.33 $0.22
=============== ================ ================ ================
Three Months Ended
September 27, September 28,
1998 1997
(in 000's, (in 000's,
except per except per
share share
amounts) amounts)
---------- -----------
Net income $2,366 $1,169
Weighted average common shares 12,920 12,609
---------- -----------
Basic earnings per common share $0.18 $0.09
========== ===========
Net income $2,366 $1,169
Weighted average common shares:
Common shares outstanding 12,920 12,609
Dilutive effect of stock
options & warrants 329 799
---------- -----------
Total weighted average common
shares 13,249 13,408
Diluted earnings per common
share $0.18 $0.09
========== ===========
Potential common shares that would have the effect of increasing
diluted income per share are considered to be antidilutive. In accordance with
SFAS No. 128, these shares were not included in calculating diluted income per
share. Accordingly, 360,0001,040,000 and 300,000 shares for the three and nine months ended
March 29,September 27, 1998 and 637,000 shares for the three and nine months ended March 31,September 28, 1997, respectively, were not included in
calculating diluted income per share for the periods presented.
Contingencies
The consolidated securities class action lawsuits previously pending
against the Company and certain of its directors and officers in the U.S.
District Court for the Middle District of North Carolina were dismissed with
prejudice on November 28, 1997. The dismissal was pursuant to a stipulation of
the named parties entered after the court granted the defendants' motions to
dismiss the consolidated complaint for failure to state a claim. No payments
were made to the plaintiffs to obtain the dismissal. By stipulating to the
dismissal with prejudice, the plaintiffs waived any right to re-file the action
or to appeal the court's order of dismissal.
11
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 withPursuant to the safe harbor"safe harbor" provisions of the Private Securities
Litigation Reform Act of 1995, readers of this documentreport are advised that itthis
document contains both statements of historical facts and forward looking
statements. Forward looking statements are subject to variouscertain 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 productsproduct enhancements,
or estimates or predictions of actions by customers, suppliers or 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 documentreport 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 possibility the Company
may be unableCompany's ability to
achievecomplete development of and successfully introduce new LED and microwave
products, to lower unit productLED and wafer costs, and develop new markets for
the conductive buffer LED product, gain a larger customer base, for the company's
LED products, increase in production volumes, price products competitively,
maintain and to
increase product yields and wafer size, potential difficulties in manufacturing
products repeatability due to the complexity of the Company's manufacturing
processes, possible price competition, potential failure to obtain continuedexpected
volume increases from existing customers, potential infringement claims by third
parties, potential inability of the Company to enforce its intellectual property
rights against others, availability and continuation of U.S. government funding
forGovernment funded
research contracts, as well as possible delays in the introduction of other new products,
and delays in customer acceptance of products and services production problems that
may result from changes in its manufacturing processes made to accommodate new
products and product improvements and other factors
discussed in the Company's report on Form 10-K for the year ended June 30, 1997 and subsequent quarterly
reports.28, 1998.
Results of Operations
Cree Research, Inc.For the first quarter ended September 27, 1998, the Company reported
record salesrevenue and net income of $10,671,000 for$12,279,000 and $2,366,000 or $0.18 per share,
respectively. These results reflect a 20% increase in revenue and a 102% rise in
net income over the thirdfirst quarter of fiscal 1998, which represents a 53% increase over the third quarter
of the prior year. On a year-to-date basis, revenue rose 51% to $30,983,000,
despite a $2,615,000 one time license fee that was included in fiscal 1997
results. Without this fee, revenue in the first nine months of fiscal 1998 would
have been 73% higher than in the corresponding prior year period.1998. Product revenue, which
includes sales of light emitting diodes ("LEDs"), and materials, module display products and moving message signs, increased 60% and 96%31%
over the thirdfirst quarter and first nine months of fiscal 1997, respectively.1998. Results for the thirdfirst quarter and first nine months of fiscal
1998 reflect the change to a 13-week quarterly periodsperiod as discussed in the Notes
to Consolidated Financial Statements.
12
AsProduct Revenue
LED sales grew 25% in the Company's LED technology continues to evolve and mature, Cree
remains focused on delivering a low-priced, high-performance, LED product line
using its proprietary gallium nitride on silicon carbide technology. In order to
reduce prices to expand markets, Cree must first lower costs to retain
consistent margins per unit. During this fiscal year, the Company has
successfully introduced a smaller chip, a larger two inch wafer and finally a
new conductive buffer product. These changes have yielded a higher performance
LED product that on average cost 29% less to manufacture during the third
quarter than the LED chip produced during the third quarter of 1997. During the
fourth quarter, Cree anticipates the completion of the transition of its LED
manufacturing to the conductive buffer technology, which is expected to reduce
average costs further. The lower cost structure realized during the past year
has enabled Cree to also lower its average sales price, which has led to a
significantly higher unit volume. This greater unit volume has improved total
LED revenue, despite the lower price per unit. Greater volume, while maintaining
margins per unit, has been and will continue to be Cree's strategy in the LED
marketplace. Many current and potential customers for the Company's products are
based in Japan and Asia. Poor economic conditions in those countries may
adversely affect the Company's ability to increase sales volume.
As a result of the lower net sales price per unit, LED sales have
increased only slightly for the quarter ended March 29, 1998fiscal 1999 as compared to the
same period in the prior year. However, duringMuch of this growth was prompted by the same time frame,128%
increase in LED unit
volume has increased over 50%. Year-to-date, LED sales revenue has increased
87% while unit volume has grown 126%shipped over the first nine months of fiscal 1997.
Most of this increase resulted from the Purchase Agreement signed withcomparable period, which was driven by
new sales in Asia and additional quantities delivered to Siemens A.G.
("Siemens") under an amendment to the parties' 1996 purchase agreement. The
amendment, signed in September 1996, which provided1998, extends Siemens' purchase commitment
through fiscal 1999 and obligates the Company to ship both the conductive buffer
and the new high brightness LED chips and silicon carbide wafers. This amendment
calls for an escalating volume ofup to a 44% increase in chip shipments over time.
In December 1997, the Company and Siemens amended the Purchase
Agreement to provide for additional shipments of LEDs to Siemens through
calendar 1998. Additional shipments are scheduled for delivery in fiscal 1999,
subject to certain rescheduling and cancellation terms. The amendment provides
for initial pricing to continue at 1998 first quarter levels,previous agreement,
with prices
declining as units increasean estimated 5% reduction in the latter part of the year. These contractual
reductions in thenet average selling price over the
duration of the contract period. The agreement also includes a change in the
product mix to Siemens will continuebe delivered through June 1999 to pressure the
company to lower production costs. The transitioninclude an increasing
percentage of all LED production tohigh brightness chips; however, the conductive buffer product may
be substituted by Siemens at a lower price, if certain quantity requirements are
not met by Cree or Siemen's customers are unable to qualify the new products. A
substitution of conductive buffer products for high brightness chips may impact
Cree's revenue for fiscal 1999 by up to $1,800,000 due to the lower pricing
associated with the conductive buffer chip. The first high brightness chips were
shipped in September 1998 on a limited basis and are expected to be delivered in
greater volumes in the fourth quarter is essential to achieving these
cost reductions. The conductive buffer LED chip, which made up only 6% of
production in thesecond and third quarter, improves efficiency in the epitaxial and wafer
fabrication manufacturing processes. In addition, the Company remains optimistic
that it can improve the manufacturing yields, which will also contribute to
overall cost reduction.quarters. However, there can be no
assurance that these efficiencieschips will be achieved.delivered or qualified by customers. The
other key effortsignificant rise in LED volume over the year ago period has been partly offset
by a 44% decline in the average sales price received. During fiscal 1999,
average sales prices for LED products are expected to continue to decline as
Cree moves to lower customer price points that are expected to stimulate greater
volume.
While the Company has been successful executionin growing LED revenue by lowering
prices and significantly raising volume, LED gross margin has increased 86% in
the first quarter of Cree'sfiscal 1999 as compared to the year ago quarter. This was
accomplished mostly by the 58% decrease in LED strategycosts per unit during the
comparable period. This significant cost reduction was caused by a combination
of technology breakthroughs in the manufacture of the LED product, which
included a smaller sized chip on a larger wafer and the introduction of the
conductive buffer chip in the fourth quarter of fiscal 1998. The conductive
buffer product reduces the complexity of manufacturing steps necessary to
produce the chip, thus lowering the cost. In addition, greater manufacturing
throughput and improved yields have also contributed to the lower cost.
The manufacturing process for higher brightness blue and green LEDs is
highly complex. Even though the Company shipped product to customers in
the first quarter of fiscal 1999, there can be no assurance that refinement of
such processes for higher yields and deliveries will be achieved in accordance
with forecasts. A delay in this manufacturing ramp could cause the Company's
results to focus efforts on obtaining additionalfall below current expectations.
For the remainder of fiscal 1999, the Company will continue the strategy
of seeking to lower LED customers.costs and expects that the greatest cost saving benefits
will be derived from increased volume and higher yield efficiency. If the
Company is unable to continue to expand its customer base,LED volume and lower its production
costs, its revenue and earnings growth may be adversely impacted. The conductive buffer technology is expected to increase the
Company's manufacturing capacity. The Company is seeking additional customers to
absorb this capacity.
13
Management
continues to believe that market growth for thisthe LED product remains dependent on
its ability to substantially lower pricing. The Company has
recently introduced the conductive buffer product to Asia and has received
positive feedback. This product, which is 50% brighter than the Company's prior
product, but which remains less bright than a higher priced competing product,
is expected to drive increased volume, however, significant impact may only be
achieved through reduced pricing. The Company continues to gain understanding of
customer price points while balancing cost opportunities . There can be no assurance that Cree will increase
its customer base,unit shipments, achieve lower costs or maintain similar margins, or that the
conductive bufferhigh brightness product will be accepted by customers. In addition, changes in the
manufacturing processesintroduction of the high brightness product line could result in unexpected
problems that could lower production during the transition period.
13
Material productsproduct sales have showncontinue to show the most dramatic increase in the
recent quarter due to contributions made by the gemstone products and microwave
technologies. Overall, sales ofthe
overall improvements made to wafer quality. As a result, revenues for material
products grew 140% and 112%,
respectively, for the three and nine months ended March 29, 1998,50% over the same periodsperiod in the prior year. Material sales have
also grown duebenefited from the added capacity available from the C3 supply agreement. During
the fourth quarter of fiscal 1998, C3 requested that Cree more than double
available capacity in order to anmeet their customer demand. Funding for the
capital expansion was provided by C3. During the first quarter of 1999
approximately 66% of this added capacity was brought on line, with the remaining
equipment scheduled for initial production in the second quarter. This added
capacity was a primary contributor for the 73% increase in wafer shipments and greater fundingrevenue recognized
from C3 over amounts recorded in the Company's Development Agreement
with C3. Under these agreements, C3 pays the Company its costs, plus a specified
margin on certain costs, for work directed to developing improved processes for
the manufacturefirst quarter of colorless material for use in gemstones. This research is
particularly important as it also funds the development of larger diameter
crystals, which is expected to assist the Company in manufacturing larger
diameter silicon carbide wafers for semiconductor applications. Total C3 sales
now comprise over 10% of product revenue year-to-date.fiscal 1998. Wafer volume
has also increased 32% as a result of the Company's success in offering wafer
products with lower defect densities, which enable customers to conduct advanced
research for microwave and power applications, and in part due to increased interest in SiC
materials in the semiconductor industry. Microwave products also contributed to
the overall revenue mix during the quarter as a result of work performed under a
development agreement executed in December 1997 with a corporate customer. This
work is particularly important as the Company's strategy to achieve significant
top line revenue growth in future years depends on the introduction of microwave
products.
Year-to-date, revenueapplications.
Revenue contributions from the display modules and moving messages sign
products were 92% higher, despite a disappointing third96% lower than the prior year as results for the first quarter thatof
1998 included a return of a significant sale made to an Asiana module customer that
ceasedin Korea. The Company
continues to redirect current investment away from this area as it analyzes the
future business operations. Prior year third quarter results also included a
significant product return reflected in this year over year comparison.plan for these products.
Contract Gross Margin
Research contract revenue and cost of contract revenue increased 25%decreased 22% and
15%27%, respectively, during the thirdfirst quarter of fiscal 19981999 as compared to the
prior year quarter. Likewise, contract revenue and cost of contract revenue
for the nine month periods increased 14% and 5% year over year,quarter, due to a change
in mixthe completion of work being performed under cost-share contract arrangements. Under
cost-share contracts, where direct costs
14
incurred are expected to exceedexisting government funding
fundingcommitments and the limitation of new funds available from the government for
research. Some of this research is recorded as an
offset tonow being funded by the Company which
resulted in a 104% increase in research and development expenses and related direct expenses are
recorded as research and development expenses. Conversely, when government
funding is anticipated to be higher than direct costs incurred, funding is
recorded as contract revenue and direct expenses are reflected as costs of
contract revenue. Duringover the
first half of fiscal 1998, resources were moved
fromcomparative period in the cost-share arrangements to other work, as funding under the cost-share
transactions was exhausted. As a result, contract revenue and costs of contract
revenue were higher.prior year.
Product Margin
The Company's product gross margin was 38%a record 46% for the three months ended
March 29, 1998. The margin was reduced by a $300,000 inventory write-down taken
on displays products. Without this adjustment, margins would have been 42% for
the third quarter ofSeptember 27, 1998 as compared to 37% reported31% in the third quarter of
the prior year. Product gross margins were 37% of revenue for the nine months
ended March 29, 1998, due to $453,000 in inventory write-downs related to
displays products. Without this adjustment, margins would have been 39% for the
period compared to 32% experienced in fiscal 1997. The overall growth in
profitability stems from higher throughput and manufacturing yield on LED and
materials products, thereby lowering the cost per unit. While the Company has
demonstrated a lower per unit cost during the past year, much of this success
was due to a combination of higher volumes processed as a result of the Siemens
contract andIn addition, technology
contributions stemming from a smaller sized chip andon a larger two inch wafer. Improvements in yieldswafer, plus the
implementation of the lower cost conductive buffer process have contributed to
this increase. Higher LED and material unit sales have also reduced unit costs for
material products.
For the three months ended March 29, 1998, researchenhanced overall
profitability.
14
Selling and development
costs decreased 24% over the third quarter of the prior year. These lower costs
resulted from higher direct costs associated with cost-share contracts being
incurred during the prior year. Work under these cost-share contracts was
completed during the first half of fiscal 1998; therefore, there are no
comparative cost-share program charges in the third quarter of 1998. For the
nine month comparative periods, researchGeneral and development costs are 3% higher due
to heavier cost-share program charges incurred in the first half of 1998.Administrative Expenses
Sales, general and administrative expenses for the three month period
ended March 29,September 27, 1998, decreasedincreased by 4%7% over the same period in the prior year
due to depreciation and rent savings experiencedincreased costs to support the growth of business. Overall as a
resultpercentage of revenue, S, G&A costs are 10% of revenue as compared to 11%
experienced in the first quarter of fiscal 1998. These costs as a percentage of
revenue are expected to remain comparable for the remainder of fiscal 1999.
Other Expenses
The Company has entered an agreement with C3 to sell equipment
manufactured by the Company at cost plus a reasonable overhead allocation in
order to increase capacity available under the supply agreement. The overhead
allocation was recorded as "other operating income"; however, the amount was
more than offset by leasehold write-offs associated with the move to the new
facility and lower legal feesfacility.
Net interest income decreased by 30% over the first quarter of fiscal 1998
as interest expense associated the Company$10,000,000 loan commitment was defendingrecorded.
Throughout fiscal 1998, much of the securities class
action lawsuit in 1997. Year-to-date expenses remained flat due to increases in
expenses being offset by two one time insurance paymentsinterest expense incurred with this
commitment was capitalized as a part of the construction improvements made to
the Company. As a
resultfacility. When certain manufacturing operations were moved to the new site
in the first quarter of fiscal 1999, portions of the dismissal of the securities class action lawsuits (see
"Contingencies" in the Notes to the Financial Statements), the Company was
reimbursed $216,000 by its insurance carrier for costs incurred in defense of
the lawsuit. In addition, as a result of a negotiated cost cap, the Company
received a $220,000 reimbursement of medical expenses that were incurred during
the year under a partially self insured health plan.
15
Included in "Other expense" year-to-date is a loss incurred on the
disposal of certain fixed assets and the write-off of $66,000 for the remaining
value of goodwillinterest associated with
the acquisitioncompleted work were expensed. For the first quarter of 1999 total interest
incurred was $196,000 with only $84,000 being eligible for capitalization,
therefore $112,000 was expensed. No interest expense was incurred in the Real Color Displays
subsidiary.
The Company's income tax provision has increased to 29% from a 5%
effective rate experienced during 1997. This higher rate results from the
utilizationfirst
quarter of net operating loss carryforwards during fiscal 1997.1998.
Liquidity and Capital Resources
Net cash provided by operations was $9,362,000$1,217,000 for the ninethree months
ended March 29,September 27, 1998 compared with $2,572,000$2,467,000 generated during the
comparative period in fiscal 1997.1998. The increasedecrease was primarily attributable to
higher profitability, lower inventorybeing offset by a significant decrease in accounts payable
and greater accrued expenses primarily arising
from increased income tax liability.expenses.
The Company invested $9,346,000$4,087,000 in capital itemsexpenditures during the first
ninethree months of fiscal 19981999 compared to $6,329,000$822,000 during the same period in the
prior year. The majority of the increase in spending was due to the acquisitioncontinued
upfit of athe new production facility near Research Triangle Park, North
Carolina. The total capital outlay for this facilityCompany also increased manufacturing capacity by adding new
equipment in the epitaxial and associated upfit is estimated to be
approximately $10,000,000 to $15,000,000. A $3,000,000 initial investment was
made to purchase the property, with the upfit expected to take place over the
next nine to twelve months.clean room departments.
The Company currently has a loan commitment of up tooutstanding for $10,000,000 from a
commercial bank to finance a portionportions of these expenditures.
Asthe upfit of March 29, 1998, approximately $4,378,000 had been drawn againstthe facility. The final draw
to this loan.
All other capital investmentsloan was made during 1998 are expected to be financed
through cash provided by operations and cash on hand. For the year, cash on hand
has also increased by $2,911,000 as a resultfirst quarter of stock option and warrant
exercises.1999 for $1,281,000. The Company believes it has sufficient capital resources to fund its
business operations. However, the
Company is presently evaluating alternativesreviewing capital requirements for fiscal 1999 and may look
for additional financing alternatives. The Company also committed $3,214,000
during the developmentquarter to repurchase Company stock.
15
Year 2000
The Company's products are of new applicationsa nature that they are not subject to
failure because of Year 2000 issues. The Company has assigned full-time
information technology professionals to the task of identifying and resolving
Year 2000 problems that may impact the Company's business and has adopted a
phased Year 2000 compliance plan. During the first phase, which is scheduled to
be completed in December 1998, the Company will inventory and collect
documentation on all of its technology,computers, computer related equipment and embedded
processors. The Company will then contact critical vendors and suppliers to
obtain assurances of their ability to ensure smooth delivery of products and
services after December 1999. In the second and third phases, the Company will
prioritize and implement necessary repairs or replacements to equipment in order
to achieve Year 2000 compliance, which it expects to complete in the first
quarter of calendar 1999. The final phase will consist of a testing program,
scheduled for completion in the second quarter of calendar 1999. The Company has
not prepared estimates of costs for the correction of Year 2000 problems. Based
on information available at this time, including its blue laser technology.
16
the Year 2000 compliance status
of equipment that has been examined as well as the anticipated replacement
schedule for equipment, the Company does not believe that the cost of remedial
actions will have a material adverse effect on the Company's results of
operations or financial condition. There can be no assurance that there will not
be delay in, or increased costs associated with, the implementation of
corrections as the Year 2000 compliance plan is performed. Failure to implement
such changes could have an adverse effect on future results of operations. In
addition, unexpected costs of correcting equipment that has not yet been fully
evaluated could have an adverse effect on future results of operations.
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
None10.15 Third Amendment to Purchase Agreement between the Company
and Siemens A.G. dated September 8, 1998 (1)
b) Reports on Form 8-K:
None.The Company filed a report on Form 8-K dated September 25, 1998
reporting in Item 4 the dismissal of PricewaterhouseCoopers LLP and
the engagement of Ernst & Young LLP as the Company's independent
accountant.
16
(1) Confidential treatment of portions of this document is being
requested pursuant to Rule 24b-2 of the Securities and Exchange
Commission.
17
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: April 29,October 30, 1998 /s/F. Neal Hunter
------------------------------------------------------------------------------------------
F. Neal Hunter, President and
Chief Executive Officer
/s/ Cynthia B. Merrell
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Cynthia B. Merrell, Chief Financial Officer
18