SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 24, 2002
Commission file number: 0-21154
CREE, 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, North Carolina 27703
(Address of principal executive offices) (Zip Code)
(919) 313-5300
(Registrant's telephone number, including area code)
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
The number of shares outstanding of the registrant's common stock, par value
$0.00125 per share, as of April 26, 2002 was 72,795,059.
CREE, INC.
FORM 10-Q
For the Quarter Ended March 24, 2002
INDEX
Page No.
--------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets at March 24, 2002 (unaudited) and
June 24, 2001 3
Consolidated Statements of Operations for the three and nine months
ended March 24, 2002 and March 25, 2001 (unaudited) 4
Consolidated Statements of Cash Flow for the nine months ended
March 24, 2002 and March 25, 2001 (unaudited) 5
Notes to Consolidated Financial Statements (unaudited) 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 15
Item 3. Quantitative and Qualitative Disclosures About Market Risk 24
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 24
Item 6. Exhibits and Reports on Form 8-K 25
SIGNATURES 26
2
PART I - FINANCIAL INFORMATION
Item 1 - Financial Statements
CREE, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except per share data)
March 24, June 24,
2002 2001
---------- ---------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 146,495 $ 164,562
Short-term investments held to maturity -- 36,965
Marketable securities 10,470 6,675
Accounts receivable, net 38,565 34,850
Interest receivable 327 1,270
Inventories 14,812 15,202
Deferred income tax 2,536 4,172
Prepaid expenses and other current assets 5,528 2,220
--------- ---------
Total current assets 218,733 265,916
Property and equipment, net 212,483 226,920
Goodwill and intangible assets, net -- 83,282
Long-term investments held to maturity 27,971 7,971
Patents, net 3,870 3,246
Deferred income tax 26,392 --
Other assets 24,485 27,788
--------- ---------
Total assets $ 513,934 $ 615,123
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable, trade $ 8,671 $ 14,147
Accrued salaries and wages 3,202 2,435
Other accrued expenses 5,005 5,156
--------- ---------
Total current liabilities 16,878 21,738
Long term liabilities:
Deferred income taxes 3,850 3,850
Other long term liabilities 38 438
--------- ---------
Total long term liabilities 3,888 4,288
Shareholders' equity:
Preferred stock, par value $0.01; 3,000 shares authorized at March -- --
24, 2002 and June 24, 2001; none issued and outstanding
Common stock, par value $0.00125; 120,000 shares authorized; 73,022 and
72,907 shares issued and outstanding at March 24, 2002 and June 24,
2001, respectively 91 91
Additional paid-in-capital 509,446 518,781
Deferred compensation expense (830) (1,211)
Retained (deficit) earnings (3,201) 76,001
Accumulated other comprehensive loss, net of tax (12,338) (4,565)
--------- ---------
Total shareholders' equity 493,168 589,097
--------- ---------
Total liabilities and shareholders' equity $ 513,934 $ 615,123
========= =========
The accompanying notes are an integral part of the
consolidated financial statements.
3
CREE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
(Unaudited)
Three Months Ended Nine Months Ended
--------------------------- ---------------------------
March 24, March 25, March 24, March 25,
2002 2001 2002 2001
--------- --------- --------- ---------
Revenue:
Product revenue, net $ 28,566 $ 48,042 $ 104,017 $ 119,940
Contract revenue, net 4,810 5,323 13,617 12,561
--------- --------- --------- ---------
Total revenue 33,376 53,365 117,634 132,501
Cost of revenue:
Product revenue 21,835 23,819 60,255 54,471
Contract revenue 3,164 3,849 9,722 9,693
--------- --------- --------- ---------
Total cost of revenue 24,999 27,668 69,977 64,164
--------- --------- --------- ---------
Gross profit 8,377 25,697 47,657 68,337
Operating expenses:
Research and development 9,327 3,627 20,181 8,023
Sales, general and administrative 6,534 5,105 17,848 12,072
In-process research and development
costs, one-time charge -- 17,400 -- 17,400
Other expense 77,434 158 97,104 220
Goodwill and intangible
asset amortization 2,255 2,280 6,765 2,280
--------- --------- --------- ---------
(Loss) income from operations (87,173) (2,873) (94,241) 28,342
Other non operating (loss) -- 162 (11,795) 63
Interest income, net 1,006 3,824 4,496 12,929
--------- --------- --------- ---------
(Loss) income before income taxes (86,167) 1,113 (101,540) 41,334
Income tax (benefit) expense (17,881) 6,295 (22,339) 20,000
--------- --------- --------- ---------
Net (loss) income $ (68,286) $ (5,182) $ (79,201) $ 21,334
========= ========= ========= =========
(Loss) earnings per share:
Basic $ (0.94) $ (0.07) $ (1.09) $ 0.30
========= ========= ========= =========
Diluted $ (0.94) $ (0.07) $ (1.09) $ 0.28
========= ========= ========= =========
Shares used in per share calculation:
Basic 72,781 73,920 72,730 72,075
========= ========= ========= =========
Diluted 72,781 73,920 72,730 75,818
========= ========= ========= =========
The accompanying notes are an integral part of the
consolidated financial statements.
4
CREE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOW
(Unaudited)
Nine Months Ended
---------------------------------
March 24, 2002 March 25, 2001
-------------- --------------
(In thousands)
Operating activities:
Net (loss) income $ (79,201) $ 21,334
Adjustments to reconcile net (loss) income to net cash
provided by operating activities:
Depreciation of property and equipment 23,611 15,016
Loss on disposal of property, equipment and other impairment charge 18,931 221
Write off of goodwill and other intangible assets 76,488 --
Acquired in process research & development, one time charge -- 17,400
Amortization of patent rights 186 142
Goodwill and intangible asset amortization 6,796 2,279
Amortization of deferred compensation 381 407
Deferred income taxes (24,839) 19,291
(Gain) on available for sale securities (558) (1,379)
Tax benefits associated with stock option exercises 2,274 --
Other than temporary decline in value of long term investments 12,352 --
Changes in operating assets and liabilities:
Accounts and interest receivable (2,772) (16,113)
Inventories 390 (2,903)
Prepaid expenses and other current assets (3,308) (618)
Accounts payable, trade (5,476) 693
Accrued expenses and other long-term liabilities 216 1,744
--------- ---------
Net cash provided by operating activities 25,471 57,514
--------- ---------
Investing activities:
Acquisition fees for purchase accounting transaction -- (1,908)
Purchase of available for sale securities (15,305) (10,318)
Proceeds from sale of available for sale securities 2,103 5,837
Purchase of property and equipment (28,105) (88,193)
Purchase of securities held to maturity (40,000) (116,528)
Proceeds from maturities of securities held to maturity 56,965 214,998
Increase in other long-term assets (9,051) (26,694)
Capitalized patent costs (810) (700)
--------- ---------
Net cash used in investing activities (34,203) (23,506)
--------- ---------
Financing activities:
Repurchase of common stock (13,640) (30,668)
Net proceeds from issuance of common stock 4,305 9,919
--------- ---------
Net cash used in financing activities (9,335) (20,749)
--------- ---------
Net (decrease) increase in cash and cash equivalents $ (18,067) $ 13,259
Cash and cash equivalents:
Beginning of period $ 164,562 $ 103,843
========= =========
End of period $ 146,495 $ 117,102
========= =========
Supplemental disclosure of cash flow information:
Cash paid for income taxes $ 1,901 $ 611
========= =========
</Table>
The accompanying notes are an integral part of the
consolidated financial statements
5
CREE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
BASIS OF PRESENTATION
The consolidated balance sheet as of March 24, 2002, the consolidated statements
of operations for the three and nine months ended March 24, 2002 and March 25,
2001, and the consolidated statements of cash flow for the nine months ended
March 24, 2002 and March 25, 2001 have been prepared by the Company and have not
been audited. In the opinion of management, all normal and recurring adjustments
necessary to present fairly the financial position, results of operations and
cash flow at March 24, 2002, and for all periods presented, have been made. The
balance sheet at June 24, 2001 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 accounting principles generally accepted
in the United States have been condensed or omitted. It is suggested that these
condensed financial statements be read in conjunction with the consolidated
financial statements and notes thereto included in the Company's fiscal 2001
Annual Report on Form 10-K. The results of operations for the period ended March
24, 2002 are not necessarily indicative of the operating results that may be
attained for the entire fiscal year.
ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of Cree, Inc., and
its wholly-owned subsidiaries, Cree Lighting Company ("Cree Lighting"), UltraRF,
Inc. ("UltraRF"), Cree Research FSC, Inc., Cree Funding LLC, Cree Employee
Services Corporation, CI Holdings, Limited, Cree Technologies, Inc and Cree
Asia-Pacific, Inc. All material intercompany accounts and transactions have been
eliminated in consolidation.
BUSINESS COMBINATION
On December 29, 2000, the Company completed the acquisition of the UltraRF
division of Spectrian Corporation, or Spectrian, through the purchase of assets
of the business by Cree's wholly owned subsidiary, UltraRF, Inc. in a business
combination accounted for under the purchase method. Under the terms of the
Asset Purchase Agreement, UltraRF acquired substantially all of the net assets
of the business from Spectrian in exchange for a total of 2,656,917 shares of
Cree common stock valued at $113.5 million. Of the total shares issued, 191,094
shares were placed in escrow and proceeds from the sale of such shares retained
in escrow to secure Spectrian's representations, warranties and covenants under
the Asset Purchase Agreement. Under the terms of the escrow arrangement,
one-half of the funds were released to Spectrian in June 2001 and the balance
was released in December 2001 because no claims were made against the escrowed
assets. The results of operations of UltraRF have been included in the
consolidated results of the Company since the date of acquisition.
6
BUSINESS SEGMENTS
The Company operates in two business segments, Cree and UltraRF. The Cree
segment incorporates its proprietary technology to produce compound
semiconductors using silicon carbide and gallium nitride technology. Products
from this segment are used in automotive and liquid crystal display
backlighting, indicator lamps, full color light emitting diode displays and
other lighting applications as well as microwave and power applications.
The UltraRF segment designs, manufactures and markets silicon-based Laterally
Diffused Metal Oxide Semiconductors or LDMOS and bipolar radio frequency power
semiconductors, utilized in building power amplifiers for wireless
infrastructure applications.
Summarized financial information concerning the reportable segments as of and
for the three and nine months ended March 24, 2002 and March 25, 2001 is shown
in the following table. The "Other" column represents amounts excluded from
specific segments such as interest income. In addition, the "Other" column also
includes corporate assets such as cash and cash equivalents, short-term
investments held to maturity, marketable securities, interest receivable and
long-term investments held to maturity which have not been allocated to a
specific segment.
As of and for the three months ended
March 24, 2002 (in thousands) Cree UltraRF Other Total
- ------------------------------------- --------- --------- --------- ---------
Revenue $ 29,885 $ 3,491 $ -- $ 33,376
(Loss) income before income taxes 104 (87,277) 1,006 (86,167)
Assets $ 313,396 $ 15,275 $ 185,263 $ 513,934
As of and for the three months ended
March 25, 2001 (in thousands) Cree UltraRF Other Total
- ------------------------------------- --------- --------- --------- ---------
Revenue $ 44,064 $ 9,301 $ -- $ 53,365
(Loss) income before income taxes 14,735 (17,446) 3,824 1,113
Assets $ 293,807 $ 102,746 $ 214,962 $ 611,515
As of and for the nine months ended
March 24, 2002 (in thousands) Cree UltraRF Other Total
- ------------------------------------- --------- --------- --------- ---------
Revenue $ 96,689 $ 20,945 $ -- $ 117,634
(Loss) income before income taxes (17,406) (88,630) 4,496 (101,540)
Assets $ 313,396 $ 15,275 $ 185,263 $ 513,934
As of and for the nine months ended
March 25, 2001 (in thousands) Cree UltraRF Other Total
- ------------------------------------- --------- --------- --------- ---------
Revenue $ 123,200 $ 9,301 $ -- $ 132,501
(Loss) income before income taxes 45,851 (17,446) 12,929 41,334
Assets $ 293,807 $ 102,746 $ 214,962 $ 611,515
7
RECLASSIFICATIONS
Certain fiscal 2001 amounts in the accompanying consolidated financial
statements have been reclassified to conform to the fiscal 2002 presentation.
These reclassifications had no effect on previously reported net income or
shareholder's equity.
FISCAL YEAR
The Company's fiscal year is a 52 or 53 week period ending on the last Sunday in
the month of June. The Company's 2002 fiscal year extends from June 25, 2001
through June 30, 2002 and is a 53-week fiscal year. The Company's 2001 fiscal
year extended from June 26, 2000 through June 24, 2001 and was a 52-week fiscal
year.
ESTIMATES
The preparation of the consolidated financial statements in conformity with
accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect the amounts reported in
the financial statements and accompanying notes. Actual amounts could differ
from those estimates.
REVENUE RECOGNITION
The Company recognizes product revenue at the time of shipment when title is
transferred to the customer in accordance with the terms of the relevant
contract. Revenue from government contracts is recorded on the
percentage-of-completion method as expenses per contract are incurred.
Contract revenue represents reimbursement by various U.S. Government entities to
aid in the development of the Company's technology. The applicable contracts
generally provide that the Company may elect to retain ownership of inventions
made in performing the work, subject to a non-exclusive license retained by the
government to practice the inventions for government purposes. Contract revenue
includes funding of direct research and development costs and a portion of the
Company's general and administrative expenses and other operating expenses for
contracts under which funding is expected to exceed direct costs over the life
of the contract. The specific reimbursement provisions of the contracts,
including the portion of the Company's general and administrative expenses and
other operating expenses that are reimbursed, vary by contract. Such
reimbursements are recorded as contract revenue. For contracts under which the
Company anticipates that direct costs will exceed amounts to be funded over the
life of the contract (i.e., certain cost share arrangements), the Company
reports direct costs as research and development expenses with related
reimbursements recorded as an offset to those expenses.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents consist of unrestricted cash accounts and highly
liquid investments with an original maturity of three months or less when
purchased.
8
FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts of cash and cash equivalents, short-term and long-term
investments, available for sale securities, accounts and interest receivable,
accounts payable, accrued expenses and other liabilities approximate fair values
at March 24, 2002 and June 24, 2001.
INVESTMENTS
Investments are accounted for in accordance with Statement of Financial
Accounting Standards No. 115, (SFAS 115) "Accounting for Certain Investments in
Debt and Equity Securities". This statement requires certain securities to be
classified into three categories:
(a) Securities Held-to-Maturity -- Debt securities that the entity
has the positive intent and ability to hold to maturity are
reported at amortized cost.
(b) Trading Securities -- Debt and equity securities that are
bought and held principally for the purpose of selling in the
near term are reported at fair value, with unrealized gains
and losses included in earnings.
(c) Securities Available-for-Sale -- Debt and equity securities
not classified as either securities held-to-maturity or
trading securities are reported at fair value with unrealized
gains and losses excluded from earnings and reported as a
separate component of shareholders' equity.
At March 24, 2002, the Company held short-term investments in the common stock
of publicly traded equity securities. The Company considers these investments to
be strategic in nature; therefore, these investments are accounted for as
"available for sale" marketable securities under SFAS 115. Therefore, unrealized
gains or losses are excluded from earnings and are recorded in other
comprehensive income or loss, net of tax. At March 24, 2002, the fair market
value of these investments was $10.5 million with gross unrealized losses
totaling $17.5 million.
As of March 24, 2002, the Company had no short-term investments held to
maturity.
As of March 24, 2002, the Company's long-term investments consisted of $28.0
million in high-grade commercial paper, medium term notes and other debt
securities that mature in June 2003 and August 2003. The Company has the intent
and ability to hold these securities until maturity; therefore, they are
accounted for as "securities held-to-maturity" under SFAS 115. These securities
are reported on the consolidated balance sheet at amortized cost, as long-term
investments with unpaid interest included in interest receivable if interest is
due in less than 12 months, and as a long term receivable if interest is due in
more that 12 months.
As of March 24, 2002, the Company maintained $24.0 million of net investments in
the equity of privately-held companies, which are included in other assets on
the consolidated balance sheet. Since the Company does not have the ability to
exercise significant influence over the operations of these companies, these
investment balances are carried at cost and accounted for using the cost method
of accounting for investments. Management conducts a quarterly impairment review
9
of each investment in the portfolio, including historical and projected
financial performance, expected cash needs and recent funding events.
Other-than-temporary impairments for investments are estimated and recognized if
the market value of the investment is estimated to be below its cost basis for
an extended period or the issuer has experienced significant financial declines
or difficulties in raising capital to continue operations. During the quarter
ending December 23, 2001, the Company recorded an impairment charge on these
investments of $12.4 million, representing the Company's best estimate of an
"other than temporary" decline in value. This impairment charge was included as
`other non-operating loss' on the consolidated statements of operations. There
were no impairment charges on its investments for the third quarter ended March
24, 2002.
IMPAIRMENT OF PROPERTY AND EQUIPMENT
In accordance with Statement of Financial Accounting Standards No. 121,
Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to be
Disposed Of ("SFAS 121"), the Company reviews long-lived assets for impairment
based on changes in circumstances that indicate their carrying amounts may not
be recoverable. During the quarter ended December 23, 2001, the Company recorded
an impairment charge for property and equipment totaling $18.1 million related
to assets to be disposed of, which is included in `other operating expense' on
the consolidated statements of operations. This impairment charge was due to
technology decisions or changes resulting in the obsolescence of the assets.
These assets are being carried at the lower of the carrying amount or fair value
less cost to sell. The majority of these impaired assets will be destroyed due
to the proprietary nature of the assets. Disposal of the impaired assets is
expected to occur during calendar year 2002. There were no impairment charges
recorded for property and equipment during the third quarter ended March 24,
2002.
INVENTORIES
Inventories are stated at the lower of cost or market, with cost determined
under the first-in, first-out (FIFO) method. It is the Company's policy to
record a reserve against inventory once it has been determined that conditions
exist which may not allow the Company to sell the inventory for its intended
purpose or it is obsolete. The Company writes inventory off when it is disposed
of. Inventories consist of the following:
March 24, June 24,
2002 2001
--------- --------
(in thousands)
Raw materials $ 4,029 $ 4,538
Work-in-progress 7,844 6,206
Finished goods 8,927 5,251
Reserve (5,988) (793)
======= =======
Total inventory, net $14,812 $15,202
======= =======
During the third quarter of fiscal 2002, the Company recorded an additional $4.9
million inventory reserve. This reserve consisted of $4.5 million related to the
UltraRF business segment and $0.4 million related to the Cree segment. The $4.5
million reserve was made up of approximately $500,000 for raw material
inventory, $3.0 million for work in process inventory and $1.0 million for
finished goods inventory. The items reserved against were primarily certain
10
bipolar and older LDMOS products that were deemed unsaleable. Also included in
the $4.9 million reserve is a $375,000 reserve for Cree LED finished goods
inventory and a $58,000 reserve for Cree raw materials. The charge for the
inventory reserves is recorded in cost of revenue on the statement of
operations.
Cree recorded the $4.5 million reserve for UltraRF inventory due to information
that was obtained during contract negotiations with Spectrian, its significant
customer, regarding specific order needs over the next several quarters.
Spectrian has purchased more than 90% of products sold by UltraRF since it was
acquired from Spectrian in December 2000. During these contract negotiations,
Spectrian indicated that it would only purchase newer LDMOS devices from UltraRF
after the fourth quarter of fiscal 2002. As a result, the Company fully reserved
for inventories of non-LDMOS and other older devices deemed unsaleable in the
fourth quarter of fiscal 2002. The Company expects to dispose of a portion of
this inventory during the June 2002 quarter and the remainder is expected to be
disposed of within the next twelve months. As a result of the downturn in
business at UltraRF, the Company also recorded $600,000 of additional product
reserves that were recorded in cost of revenue on the statement of operations.
GOODWILL AND INTANGIBLE ASSETS
During the third quarter of fiscal 2002, the Company determined that business
conditions for its UltraRF unit had changed due to several factors. First,
UltraRF amended its supply agreement with Spectrian effective March 31, 2002
which resulted in a significant reduction in quarterly revenue expectations. In
addition, UltraRF's outlook for acquiring additional customers in the near term
weakened due to the deteriorating economic conditions and the long qualification
cycles. Also, many of the products that Spectrian initially indicated it would
purchase in the future have not yet been released to production. Under the
amended supply agreement, if UltraRF is not able to produce LDMOS 8 devices
qualified for Spectrian's applications in a timely manner revenue may be
significantly reduced from Spectrian after the June 2002 quarter. Accordingly,
the Company wrote-off the entire balance of goodwill and other purchased
intangibles related to UltraRF, recorded additional reserves related to
inventory and incurred other related charges such as severance. Based on these
impairment indicators, the Company performed an asset impairment analysis in
accordance with SFAS No. 121, Impairment of Long-Lived Assets. As a result of
this analysis, the remaining balance of goodwill and intangible assets of $76.5
million was deemed to be fully impaired, and was written off during the third
quarter. This write-off was recorded as "other expense" on the statement of
operations. See "Significant Sales Contracts."
RESEARCH AND DEVELOPMENT ACCOUNTING POLICY
The U.S. Government provides funding through research contracts for several of
the Company's current research and development efforts. The contract funding may
be based on a cost-plus, a cost-share or a firm fixed price 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 the cost of capital expenses. Cost-plus funding is
determined based on actual costs plus a set percentage margin. For the
cost-share contracts, the actual costs are divided between the U.S. government
and the Company based on the terms of the contract. The government's cost share
is then paid to the Company. Activities performed under these arrangements
include research regarding silicon carbide and gallium nitride
11
materials. The contracts typically require the submission of a written report
that documents the results of such research.
The revenue and expense classification for contract activities is 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 Nine Months Ended
---------------------------- ---------------------------
March 24, March 25, March 24, March 25,
2002 2001 2002 2001
--------- --------- --------- ---------
(In thousands)
Net R&D costs $ (18) $ 160 $ 42 $ 399
Government funding 22 371 251 1,031
------ ------ ------ ------
Total direct costs incurred $ 4 $ 531 $ 293 $1,430
====== ====== ====== ======
SIGNIFICANT SALES CONTRACTS
On September 21, 2001, the Company entered into a new Purchase Agreement with
Osram Opto Semiconductors GmbH & Co. ("Osram"), pursuant to which Osram agreed
to purchase and the Company is obligated to ship certain quantities of LED chips
and silicon carbide wafers through September 2002.
The Purchase Agreement calls for certain quantities of LED chips to be delivered
each month unless shipment is deferred by Osram under the deferred shipment
notice provisions of the Purchase Agreement. Pursuant to such provisions, as
indicated in our report on Form 10-Q for the period ended December 23, 2001,
Osram elected to defer a portion of the original contracted amount to a later
quarter than originally scheduled. In any event, the Purchase Agreement requires
Osram to purchase all products by March 24, 2003. The Purchase Agreement also
provides for liquidated damages if the Company is unable to ship at least 85% of
the cumulative quantity due to have been shipped each month. These damages are
calculated at one percent per week of the purchase price of the delayed product,
subject to a maximum of ten percent of the purchase price. If product shipments
are delayed nine weeks or more due to circumstances within the Company's
control, then in lieu of liquidated damages, Osram may claim damages actually
resulting from the delay up to forty percent of the purchase price of delayed
products.
Additionally, the Purchase Agreement provides for higher 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
offset higher per unit costs expected earlier in the contract.
12
In December 2000, the Company's subsidiary, UltraRF, entered into a Supply
Agreement with Spectrian. Under this agreement, Spectrian committed to purchase
semiconductor components having a minimum aggregate purchase price of
approximately $58 million during the two years ended December 31, 2002. This
agreement was amended effective March 31, 2002 to extend the term of the
agreement through June 2003, to reduce the total contractual commitment to $54.8
million and to reduce the quarterly revenue commitment to be more in line with
Spectrian's current product demand. In addition, UltraRF agreed to allocate
sufficient capacity to supply Spectrian with quantities in excess of its minimum
commitment by up to 20%. The minimum purchase amounts are fixed under the
amended agreement. Additionally, if UltraRF is unable to produce LDMOS 8 devices
qualified for Spectrian's applications by June 30, 2002, Spectrian's obligation
to purchase devices from UltraRF will be substantially reduced or eliminated
until the required LDMOS 8 parts are qualified.
INCOME TAXES
The Company has established an estimated tax provision based upon an effective
rate of 22% for the quarter ended March 24, 2002. The Company's effective tax
rate was 34% for the quarter ended March 25, 2001. The decrease in the effective
tax rate is due to the charges recorded during the third quarter of fiscal 2002
related to the downturn in the UltraRF business. The estimated effective rate
was based upon projections of income for the fiscal year and the Company's
estimate that it will be able to fully utilize its deferred tax assets. However,
the actual effective rate may vary depending upon actual pre-tax book income for
the year or other factors.
SHAREHOLDERS' EQUITY
On January 18, 2001, the Company announced that its Board of Directors
authorized the repurchase of up to four million shares of its outstanding common
stock. On March 22, 2001, the Company announced that its Board of Directors
increased the repurchase limits under the stock repurchase program announced in
January 2001 to include an additional three million shares, for a total of seven
million shares of its outstanding common stock. For the three and nine month
periods ended March 24, 2002, the Company repurchased 225,000 shares and 930,000
shares, respectively, of its common stock. Year to date, the Company paid an
average price of $14.66 per share to acquire this stock with an aggregate value
of approximately $13.6 million. In February, 2002, the Board of Directors
approved the renewal of this program which had expired in January 2002, through
January 31, 2003 for the purchase of up to an additional 4,445,000 shares.
The Company intends to use available cash to finance purchases under the
program, which extends to January 2003. At the discretion of the Company's
management, the repurchase program can be implemented through open market or
privately negotiated transactions. The Company will determine the time and
extent of repurchases based on its evaluation of market conditions and other
factors.
13
COMPREHENSIVE (LOSS) INCOME
Comprehensive (loss) income consists of the following:
Three Months Ended Nine Months Ended
---------------------------- -----------------------------
March 24, March 25, March 24, March 25,
2002 2001 2002 2001
--------- --------- --------- ---------
(in thousands) (in thousands)
Net (loss) income $(68,286) $ (5,182) $(79,201) $ 21,334
Other comprehensive income (loss), net of
tax (3,146) (1,010) (7,773) (7,960)
-------- -------- -------- --------
Comprehensive (loss) income $(71,432) $ (6,192) $(86,974) $ 13,374
======== ======== ======== ========
EARNINGS PER SHARE
The Company presents earnings per share in accordance with Statement of
Financial Accounting Standards No. 128, "Earnings Per Share" ("SFAS 128"). The
following computation reconciles the differences between the basic and diluted
presentations:
Three Months Ended Nine Months Ended
---------------------------- -----------------------------
March 24, March 25, March 24, March 25,
2002 2001 2002 2001
--------- --------- --------- ---------
(In thousands, except per share amounts)
Net (loss) income $(68,286) $ (5,182) $(79,201) $ 21,334
Weighted average common shares 72,781 73,920 72,730 72,075
-------- -------- -------- --------
Basic (loss) earnings per common share $ (0.94) $ (0.07) $ (1.09) $ 0.30
======== ======== ======== ========
Net (loss) income $(68,286) $ (5,182) $(79,201) $ 21,334
Diluted weighted average common shares:
Common shares outstanding 72,781 73,920 72,730 72,075
Dilutive effect of stock options and warrants -- -- -- 3,743
-------- -------- -------- --------
Total diluted weighted average common shares 72,781 73,920 72,730 75,818
-------- -------- -------- --------
Diluted (loss) earnings per common share $ (0.94) $ (0.07) $ (1.09) $ 0.28
======== ======== ======== ========
Potential common shares that would have the effect of increasing diluted income
per share are considered to be antidilutive. In accordance with SFAS 128, for
the three and nine months ended March 24, 2002, 9,781,000 and 8,839,000 shares,
respectively, were not included in calculating diluted earnings per share and
for the three months and nine months ended March 25, 2001, 5,951,074 shares were
not included in calculating diluted earnings per share because the effect would
be antidilutive.
14
NEW ACCOUNTING PRONOUNCEMENTS
On June 29, 2001, the Financial Accounting Standards Board ("FASB") unanimously
approved the issuance of Statements of Financial Accounting Standards ("SFAS")
No. 141, "Business Combinations", and No. 142, "Goodwill and Other Intangible
Assets". SFAS 141 eliminates the pooling-of-interests method of accounting for
business combinations except for qualifying business combinations that were
initiated prior to July 1, 2001. SFAS 141 also includes new criteria to
recognize intangible assets separately from goodwill. The requirements of SFAS
141 are effective for any business combination accounted for by the purchase
method that is completed after June 30, 2001. Under SFAS 142, goodwill and
intangible assets with indefinite lives are no longer amortized but are reviewed
annually, or more frequently if impairment indicators arise, for impairment.
Separable intangible assets that are not deemed to have an indefinite life will
continue to be amortized over their useful lives. The amortization provisions of
SFAS 142 requiring nonamortization of goodwill and indefinite lived intangible
assets apply to goodwill and indefinite lived intangible assets acquired after
June 30, 2001. With respect to goodwill and intangible assets acquired prior to
July 1, 2001, we are required to adopt SFAS 142 in the fiscal year beginning
July 1, 2002.
Statements of Financial Accounting Standards No. 144 ("SFAS 144") provides
guidance on differentiating between assets held and used and assets to be
disposed of. The distinction is important because assets to be disposed of must
be stated at the lower of the assets' carrying amount or fair value less cost to
sell, and depreciation is no longer recognized. Assets to be disposed of would
be classified as held for sale (and depreciation would cease) when management,
having the authority to approve the action, commits to a plan to sell the
asset(s) meeting all required criteria. If the plan of sale criteria are met
after the balance sheet date but before issuance of the financial statements,
the related asset would continue to be classified as held and used at the
balance sheet date. Unless the undiscounted cash flow test indicated a loss was
necessary on the balance sheet date, no loss would be recognized even if the
asset is expected to be sold at a loss.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
INFORMATION SET FORTH IN THIS FORM 10-Q, INCLUDING MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTAINS VARIOUS
"FORWARD LOOKING STATEMENTS" WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES
ACT OF 1933 AND SECTION 21E OF THE SECURITIES ACT OF 1934. THESE STATEMENTS
REPRESENT THE COMPANY'S JUDGMENT CONCERNING THE FUTURE AND ARE SUBJECT TO RISKS
AND UNCERTAINTIES THAT COULD CAUSE OUR ACTUAL OPERATING RESULTS AND FINANCIAL
POSITION TO DIFFER MATERIALLY. SUCH FORWARD-LOOKING STATEMENTS CAN BE IDENTIFIED
BY THE USE OF FORWARD-LOOKING TERMINOLOGY SUCH AS "MAY," "WILL," "ANTICIPATE,"
"BELIEVE," "PLAN," "ESTIMATE," "EXPECT," AND "INTEND" OR THE NEGATIVE THEREOF OR
OTHER VARIATIONS THEREOF OR COMPARABLE TERMINOLOGY. THE COMPANY CAUTIONS THAT
SUCH FORWARD-LOOKING STATEMENTS ARE FURTHER QUALIFIED BY IMPORTANT FACTORS THAT
COULD CAUSE THE COMPANY'S ACTUAL OPERATING RESULTS TO DIFFER MATERIALLY FROM
THOSE FORWARD-LOOKING STATEMENTS. THESE FACTORS INCLUDE, BUT ARE NOT LIMITED TO,
UNCERTAINTY REGARDING ECONOMIC CONDITIONS; RISKS FROM INCREASED COMPETITION;
UNCERTAIN PRODUCT DEMAND; UNCERTAINTY WHETHER CREE CAN ACHIEVE OUR TARGETS FOR
INCREASED YIELDS AND COST REDUCTIONS NEEDED TO MAINTAIN OUR MARGINS; RISKS
ASSOCIATED WITH THE PRODUCTION RAMP-UP FOR NEW PRODUCTS; INCLUDING THE
POSSIBILITY OF UNEXPECTED DELAYS, INCREASED COSTS AND MANUFACTURING DIFFICULTIES
OR
15
LESS THAN EXPECTED MARKET ACCEPTANCE; RISKS ASSOCIATED WITH THE PLANNED RELEASE
OF NEW PRODUCTS UNDER DEVELOPMENT, INCLUDING THE POSSIBILITY CREE WILL BE UNABLE
TO DEVELOP AND MANUFACTURE COMMERCIALLY VIABLE VERSIONS OF SUCH PRODUCTS; THE
RISK OF VARIABILITY IN OUR MANUFACTURING PROCESSES THAT CAN ADVERSELY AFFECT
YIELDS AND PRODUCT PERFORMANCE; THE RISK THAT OUR INVESTMENTS IN THIRD PARTIES
WILL GENERATE LOSSES; THE RISK THAT CHANGES IN CUSTOMER CONCENTRATION WILL
ADVERSELY AFFECT OUR SALES; THE POSSIBILITY OF ADVERSE RESULTS IN OUR PENDING
INTELLECTUAL PROPERTY LITIGATION; UNCERTAINTY WHETHER OUR INTELLECTUAL PROPERTY
RIGHTS WILL PROVIDE MEANINGFUL PROTECTION AND CONCENTRATION OF OUR BUSINESS
AMONG FEW CUSTOMERS. SEE EXHIBIT 99.1 FOR FURTHER DISCUSSION OF FACTORS THAT
COULD CAUSE THE COMPANY'S ACTUAL RESULTS TO DIFFER.
OVERVIEW
Cree, Inc. is an advanced semiconductor company that leverages its expertise in
silicon carbide (SiC), gallium nitride (GaN) and silicon (Si) materials
technology to produce new and enabling semiconductors. Product revenue is
recognized at the time of shipment when legal title transfers to our customers
or in accordance with the terms of the relevant contract. Our financial
statements also include estimates by management for reserves for inventory,
accounts receivable and investments in privately held companies. We derive the
largest portion of our revenue from the sale of blue and green light emitting
diode ("LED") products. We offer LEDs at four brightness levels- XBright(TM)
blue, green and ultraviolet, MegaBright(TM) blue, green and ultraviolet, high
brightness blue and green products and standard brightness blue products. Our
LED devices are utilized by end users for automotive dashboard lighting, LCD
backlighting, including wireless handsets and other consumer products, indicator
lamps, miniature white lights, indoor sign and arena displays, outdoor full
color displays, traffic signals and other lighting applications.
We began production of our new XBright LED technology in the third quarter of
2002. The XBright family of LEDs is being designed to offer increased brightness
by up to 50 percent over the MegaBright family of LED's. Target applications for
the XBright devices include solid state illumination, cell phones, automotive
and video screens. These products have gained strong initial interest from our
customers, but will require a longer design-in cycle that is expected to
continue for several months.
We also recently introduced the 505 nanometer traffic signal green and 525
nanometer signage green devices in the MegaBright product line. These diodes
exhibit typical brightness increase of greater than two times the
UltraBright(TM) device brightness levels. The target applications for the
MegaBright green devices are traffic signals, display signs and consumer
products. During the first nine months of fiscal 2002, the MegaBright blue and
green products made up 31% of our LED revenue. Our remaining LED revenue is
generated from sales of our high brightness (including UltraBright) blue and
green devices and our standard brightness blue devices.
Revenue from the UltraRF segment was $20.9 million during the first nine months
of fiscal 2002. In the long term, UltraRF's success will depend on the rate at
which we diversify our Spectrian-concentrated business and commercialize our new
LDMOS-8 technology. Currently over 90% of the sales of the UltraRF subsidiary
are made to Spectrian under a supply contract which was entered into when we
acquired UltraRF from Spectrian in December, 2000 and was subsequently modified.
The amended supply agreement expires on June 30, 2003. We believe that the
introduction of our new module products and LDMOS-8 RF power transistor devices,
16
along with our continued commitment to LDMOS research and development, may
generate product design wins from new customers, but the timing of revenue from
new customers is uncertain at this time. We also believe that Spectrian will
continue to be a customer after the expiration of the supply contract; however,
the level and pricing of sales to Spectrian will be subject to market conditions
once the supply contract expires. In addition, if UltraRF is unable to produce
LDMOS 8 devices in a timely manner after June 2002, revenue may be significantly
reduced.
We derive additional revenue from the sale of advanced materials made from SiC
that are used for manufacturing LEDs and power devices by our customers or for
research and development for new semiconductor applications.
The balance of our revenue is derived from government research contract funding.
The following table shows our statement of operations data expressed as a
percentage of total revenue for the periods indicated:
Three Months Ended Nine Months Ended
------------------------- --------------------------
March 24, March 25, March 24, March 25,
2002 2001 2002 2001
--------- --------- --------- ---------
Revenue:
Product revenue, net 86.0% 90.0% 88.0% 91.0%
Contract revenue, net 14.0 10.0 12.0 9.0
----- ----- ----- -----
Total revenue 100.0 100.0 100.0 100.0
Cost of Revenue:
Product revenue, net 66 45 51 41
Contract revenue, net 9 7 8 7
----- ----- ----- -----
Total cost of revenue 75 52 59 48
----- ----- ----- -----
Gross margin 25 48 41 52
Operating Expenses:
Research & development 28 7 17 6
Sales, general and administrative 20 10 15 9
Other expense 232 33 83 13
Intangible asset amortization 7 4 6 2
----- ----- ----- -----
(Loss) Income from operations (262) (6) (80) 22
Other non-operating (expense) income 0 0 (10) 0
Interest income, net 3 7 4 10
----- ----- ----- -----
(Loss) Income before income taxes (259) 1 (86) 31
Income tax (benefit) expense (54) 11 (19) 15
----- ----- ----- -----
Net (loss) income (205)% (10)% (67)% 16%
----- ----- ----- -----
17
RESULTS OF OPERATIONS
THREE MONTHS ENDED MARCH 24, 2002 AND MARCH 25, 2001
REVENUE. Revenue decreased 37.5% to $33.4 million in the third quarter of fiscal
2002 from $53.4 million in the third quarter of fiscal 2001. This decrease was
attributable to lower product revenue of $28.6 million in the third quarter of
fiscal 2002 from $48.0 million in the third quarter of fiscal 2001. For the
third quarter of fiscal 2002, LED revenue declined 40% and LED chip volume
decreased 26% over the third quarter of last year. Average LED sales prices
declined 20% in the third quarter of fiscal 2002 compared to the third quarter
of fiscal 2001 due to expected contractual volume discounts given to customers.
Our MegaBright LED products, which first began shipping in July 2001, showed
increasing customer acceptance as they grew to 46% of LED revenue during the
third quarter. The MegaBright and XBright products will likely continue to
replace some of the demand for older devices, as new customer product
qualifications are completed. In December 2001, we sampled our first XBright
products. We began shipping this product during the third quarter of 2002. These
products have shown good customer interest as they grew to 5% of LED revenue. As
a result of the growth of our MegaBright and XBright products, our high
brightness chips (including UltraBright chips) declined from 81% of LED sales in
the third quarter of fiscal 2001 to 34% of LED sales for the third quarter of
fiscal 2002. Sales of our standard brightness chips declined to 15% of LED
revenue in the third quarter of fiscal 2002 compared to 19% of LED sales for the
third quarter of fiscal 2001.
We saw a trend in the third quarter of 2002 for our LED sales activities where
orders from our larger customers slowed while orders from traditionally smaller
customers increased. This change in customer mix improves the balance of our
revenue stream as we decrease our customer concentration. However, this change
also limits order visibility as our new growing customers generally do not order
as far in advance as our traditional large customers. If the volume of orders
from these smaller customers does not reach the level we currently anticipate,
revenue for the fourth quarter of 2002 could be less than expected. We have
recently experienced increased demand for our LED products resulting from the
design of nitride LEDs in new wireless handset designs and other applications;
therefore, we target LED revenue to grow sequentially during our fourth quarter.
Revenue from the UltraRF segment declined 62% to $3.5 million during the third
quarter fiscal 2002 from $9.3 million in the third quarter of fiscal 2001.
Revenue was lower as we were not able to fully qualify the release our new
LDMOS-8 devices during the quarter. For the quarter, LDMOS products made up over
70% of revenue due to demand from Spectrian. UltraRF continues to ramp its
production of LDMOS products currently being shipped for next generation
wireless base station applications. We now target to ramp LDMOS-8 production
during the June 2002 quarter. If we are not successful with this product ramp,
revenue from this unit may decline after the fourth quarter of fiscal 2002.
Material sales declined 10% in the third quarter of fiscal 2002 compared to the
same period of fiscal 2001. SiC wafer sales revenue decreased 19% in the third
quarter of fiscal 2002 compared to the same period of the prior year. Wafer
units shipped increased 6%, while average sales prices declined 24% in the third
quarter of fiscal 2002 compared to the third quarter of fiscal 2001 due to a
shift in product mix and contractual pricing declines. Sales of gemstone
material
18
increased during the March 2002 quarter over the prior year; however these
products are a small portion of overall revenue.
Contract revenue received from U.S. Government agencies and non-governmental
customers decreased 10% during the third quarter of fiscal 2002 compared to the
third quarter of fiscal 2001 due to the timing of funding and work performed.
Due to recent government funding awards, we target contract revenue to increase
sequentially during our fourth quarter of fiscal 2002.
GROSS PROFIT. Gross profit decreased 67% to $8.4 million in the third quarter of
fiscal 2002 compared to $25.7 million in the third quarter of fiscal 2001.
Compared to the prior year period, gross margin for the fiscal 2002 quarter
decreased to 25% from 48% of revenue. The decrease is primarily due to a $5.1
million increase in inventory and other reserves associated with UltraRF, as
well as a $433,000 increase in reserves for our LED business. The Company
recorded these additional reserves due to the deteriorating conditions of the
UltraRF business and the re-negotiated supply agreement with its significant
customer. Without these additional reserves, gross margin from operations would
have been 42%. Gross margin for the third quarter of fiscal 2002 at UltraRF was
16% of revenue excluding the inventory and other reserves recorded in March
2002. Profitability at UltraRF was lower than the prior sequential quarter due
to the charges taken during the quarter and a shift in product mix favoring a
higher percentage of LDMOS products in comparison to bipolar products. LDMOS
products had a lower average selling price and lower gross margins relative to
the bipolar products. In addition, during the third quarter of fiscal 2002,
UltraRF incurred almost $1 million in scrap costs associated with LDMOS8
products. The LED product line realized lower profitability during March 2002 in
comparison to the prior year period due to an overall 20% decline in average
sales prices as a result of contractual provisions, a more aggressive pricing
strategy for our MegaBright products and general market conditions. At this
time, we target future LED average sales prices to decline at a slower rate. We
continue to focus on cost reduction as one of our highest priorities. We plan to
manage our expense structure and reduce costs though process improvements and
other efficiencies and to increase overall yields.
In December 2000, the Company's subsidiary, UltraRF, entered into a Supply
Agreement with Spectrian. Under this agreement, Spectrian has committed to
purchase semiconductor components having a minimum aggregate purchase price of
approximately $58 million during the two years ended December 31, 2002. This
agreement was amended effective March 31, 2002 to extend the terms of the
agreement through June 2003, to reduce the total contractual commitment to $54.8
million and to reduce the quarterly revenue commitment to be more in line with
Spectrian's current product demand. In addition, UltraRF agreed to allocate
sufficient capacity to supply Spectrian with quantities in excess of its minimum
commitment by up to 20%. The minimum purchase amounts are fixed under the
amended agreement. If UltraRF is unable to produce in a timely manner LDMOS 8
devices qualified for Spectrian's applications, revenue may be significantly
reduced from Spectrian after the June 2002 quarter.
RESEARCH AND DEVELOPMENT. Research and development expenses increased 157%, or
$5.7 million, in the third quarter of fiscal 2002 to $9.3 million from $3.6
million in the third quarter of fiscal 2001. Increased spending for research and
development results from increased internal funding to support significant LED
programs for the release of our XBright lines as well as green products for our
MegaBright devices and power chip products. We also funded work for lasers,
microwave and power programs. We anticipate that the internal funding for R&D
may be
19
reduced sequentially during the fourth quarter as we anticipate LDMOS-8,
MegaBright and XBright products to migrate to production.
SALES, GENERAL AND ADMINISTRATIVE. Sales, general and administrative expenses
increased 28%, or $1.4 million, in the third quarter of fiscal 2002 to $6.5
million from $5.1 million in the third quarter of fiscal 2001. The majority of
the increase is due to the significant legal costs primarily associated with
ongoing intellectual property litigation and higher director and officer
liability insurance premiums. We target these expenses to remain as a similar
percentage of revenue over the next quarter.
OTHER EXPENSE. Other expense was $77.4 million during the third quarter of
fiscal 2002. This was primarily made up of the $76.5 million write down of
goodwill and intangible assets relating to UltraRF. UltraRF has amended its
supply agreement with Spectrian, which reduced quarterly revenue expectations.
In addition, the outlook for acquiring additional customers in the near-term
has weakened due to the economy and the long qualification cycles. Also, many of
the products that Spectrian indicated that they would purchase in the future
have not yet been released to production. Under the amended supply agreement, if
UltraRF is not able to produce LDMOS 8 devices in a timely manner, revenue may
be significantly reduced from Spectrian after the June 2002 quarter. As a
result, the Company recorded reserves on inventory and other charges. The change
in the outlook for business at UltraRF and the reduction in expected revenue per
quarter required the Company to perform an asset impairment analysis under SFAS
121. As a result of this analysis, the full amount of goodwill and intangible
assets of $76.5 million was written off and was recorded as other expense on the
statement of operations. Also, included was $875,000 related to severance
payments and other expenses related to the change in the UltraRF business. Other
expense was $158,000 in the third quarter of fiscal 2001 relating to the
disposal of fixed assets.
OTHER NON OPERATING INCOME. In the third quarter of fiscal 2001, the Company
recorded $162,000 in non-operating income related to income received from the
sale of trading securities in the period.
GOODWILL AND INTANGIBLE ASSET AMORTIZATION. As a result of the acquisition of
UltraRF in December 2000, we recorded goodwill and other intangible assets on
the balance sheet, which was being amortized over periods ranging from 5 to 10
years. For the quarters ended March 24, 2002 and March 25, 2001, $2.2 million
was recorded as amortization expense in each period. During the third quarter
2002, the remaining balance of $76.5 million of goodwill and intangible assets
was determined to be fully impaired and was written off completely.
INTEREST INCOME, NET. Interest income, net declined $2.8 million or 74%, in the
third quarter of fiscal 2002 in comparison to the third quarter of fiscal 2001.
The reduction from the comparative quarter results primarily from lower interest
rates available for our liquid cash as a result of aggressive interest rate cuts
by the Federal Reserve.
INCOME TAX (BENEFIT) EXPENSE. Income tax benefit for the third quarter of fiscal
2002 was $17.9 million compared to an income tax expense of $6.3 million in the
third quarter of fiscal 2001. The income tax benefit resulted from the $82.5
million in charges related to the UltraRF unit. This charge was made up of
$875,000 related to severance and other expenses, $5.1 million in inventory and
other reserves and $76.5 million related to goodwill and intangible asset
20
impairment. Also, our effective tax rate changed from 29% to 22% during the
third quarter of 2002. The effective income tax rate was 22% for the third
quarter of fiscal 2002 compared to a 34% rate during the comparative period in
fiscal 2001. The Company has recorded a $26.4 million deferred tax asset
associated with the charges taken in the quarter. We target the Company to
generate future profits that will use this tax benefit over time, therefore, no
reserve was taken against this asset.
NINE MONTHS ENDED MARCH 24, 2002 AND MARCH 25, 2001
REVENUE. Revenue decreased 11.2% to $117.6 million in the first nine months of
fiscal 2002 from $132.5 million in the first nine months of fiscal 2001. This
decrease was attributable to lower product revenue of $104.0 million in the
first nine months of fiscal 2002 from $119.9 million in the first nine months of
fiscal 2001. For the first nine months of fiscal 2002, LED revenue declined 25%
from the prior year period and LED chip volume remained flat compared to the
first nine months of last fiscal year. Average LED sales prices declined 25% in
the first nine months of fiscal 2002 compared to the first nine months of fiscal
2001 due to expected contractual volume discounts given to customers and due to
market conditions. Our new MegaBright LED products showed increasing customer
acceptance as they grew to 31% of LED revenue during the first nine months of
fiscal 2002. As a result of the growth of these products, our high brightness
chips (including UltraBright chips) declined from 81% of LED sales in the first
nine months of fiscal 2001 to 43% of LED sales for the first nine months of
fiscal 2002. Sales of our standard brightness chips remained strong at 24% of
total LED revenue in the first nine months of fiscal 2002, compared to 20%
during the first nine months of fiscal 2001. Overall LED revenue declined due to
weaker economic conditions experienced in fiscal 2002, as lower average sales
prices were not offset with higher volumes.
Revenue from UltraRF was $20.9 million during the first nine months of fiscal
2002 with an even split of bipolar and LDMOS products being shipped. Most of the
revenue demand was generated from Spectrian. Sales for UltraRF for the third
quarter 2001 were $9.3 million. UltraRF was acquired in December 2000;
therefore, there were no sales for this unit in the first six months of fiscal
2001.
Material sales declined 24% in the first nine months of fiscal 2002 compared to
the same period of fiscal 2001 due to significantly lower gemstone sales. Sales
of gemstone products declined 72%, as there were only nominal sales during the
first nine months of fiscal 2002. SiC wafer sales decreased 6% in the first nine
months of fiscal 2002 compared to the prior year period. This is due to lower
average sales prices. Wafer units increased 16%, while average sales prices
declined 21% in the first nine months of fiscal 2002 compared to the first nine
months of fiscal 2001 due to product mix and contractual price declines.
Contract revenue received from U.S. Government agencies and non-governmental
customers increased 8.4% during the first nine months of fiscal 2002 compared to
the first nine months of fiscal 2001 due to larger microwave contract awards
received.
GROSS PROFIT. Gross profit decreased 30% to $47.7 million in the first nine
months of fiscal 2002 compared to $68.3 million in the first nine months of
fiscal 2001. Compared to the first nine months of the prior year, gross margin
for fiscal 2002 decreased to 41% from 52% of revenue. Gross margin for the first
nine months of fiscal 2002 at UltraRF was 41% of revenue, excluding
21
charges taken for inventory and other reserves. The LED product line realized
lower gross margins during that period in comparison to the prior year period
due to contractual declines in average sales prices and general market
conditions amounting to a 25% reduction in sales price. Lower sales prices were
slightly offset by 11% lower manufacturing costs. We continue to focus on cost
reduction as one of our highest priorities. We plan to manage our expense
structure and reduce costs though process improvements and other efficiencies
and to increase overall yields. Gross margins also declined on materials revenue
as wafer costs for SiC material sales were also higher comparing the first half
of fiscal 2002 results to the first half of fiscal 2001 due to a change in
product mix.
RESEARCH AND DEVELOPMENT. Research and development expenses increased 152% or
$12.2 million in the first nine months of fiscal 2002 to $20.2 million from $8.0
million in the first nine months of fiscal 2001. Increased spending for research
and development results from the combination of UltraRF expenses for a nine
month period and significantly increased internal funding to support new LED
device and microwave, laser and power programs. UltraRF expenses were not
included in results for the first six months of fiscal 2001 as the unit was
acquired in December 2000.
SALES, GENERAL AND ADMINISTRATIVE. Sales, general and administrative expenses
increased 48%, or $5.8 million, in the first nine months of fiscal 2002 to
$17.8 million from $12.1 million in the first nine months of fiscal 2001. The
increase is due to the combination of UltraRF expenses for a nine month period
and significant legal costs in the first nine months of fiscal 2002 primarily
associated with ongoing intellectual property litigation. UltraRF expenses were
not included in results for the first six months of fiscal 2001 as the unit was
acquired in December 2000.
OTHER EXPENSE. Other expense was $97.1 million during the first nine months of
fiscal 2002. This is made up of a $19.0 million charge for the impairment of
fixed assets recorded during December 2001 due to technology changes and a
one-time bonus of $700,000 for UltraRF employees. It also includes a $76.5
million write down of goodwill and intangible assets and a charge of $875,000
related to severance payments and other expenses related to the change in
UltraRF's business.
OTHER NON OPERATING (LOSS). The other non operating (loss) of $11.8 million in
the first nine months of fiscal 2002 was attributed to an "other than temporary"
decline in value related to our long-term investments held in privately held
companies in the amount of $12.4 million recorded in December 2001. This charge
was partially offset by a gain on the sale of marketable securities of $600,000.
GOODWILL AND INTANGIBLE ASSET AMORTIZATION. As a result of the acquisition of
UltraRF in December 2000, we recorded goodwill and other intangible assets on
the balance sheet, which was being amortized over periods ranging from 5 to 10
years. For the nine months ended March 24, 2002 and March 25, 2001, amortization
expense was $6.8 million and $2.3 million, respectively. During the third
quarter 2002, the remaining balance of $76.5 million of goodwill and intangible
assets was determined to be fully impaired and was written off completely.
INTEREST INCOME, NET. Interest income, net declined $8.4 million, or 65%, in the
first nine months of fiscal 2002 compared to the first nine months of fiscal
2001. The reduction from the
22
comparative quarter results primarily from lower interest rates available for
our liquid cash as a result of aggressive federal interest rate cuts by the
Federal Reserve.
INCOME TAX (BENEFIT) EXPENSE. Income tax benefit for the first nine months of
fiscal 2002 was $22.3 million compared to an income tax expense of $20.0 million
in the first nine months of fiscal 2001. The income tax benefit resulted from
the $101.5 million net pre-tax loss which was due to the charges for the
impairment of fixed assets of $18.1 million, the $12.4 million reserve for
investments in privately held companies, the $76.5 million write down of
goodwill and other intangibles and the $5.1 million reserve taken for inventory
and other items. The effective income tax rate was 22% for the first nine months
of fiscal 2002 compared to 34% during the comparative period of fiscal 2001.
LIQUIDITY AND CAPITAL RESOURCES
We have funded our operations to date through sales of equity, bank borrowings
and revenue from product and contract sales. As of March 24, 2002 we had working
capital of $201.9 million, including $157.0 million in cash and marketable
securities. Operating activities generated net cash of $25.5 million for the
first nine months of fiscal 2002 compared with $56.8 million generated during
the comparative period in fiscal 2001. This reduction in cash provided by
operations was primarily attributable to lower income from operations and timing
differences attributable to our increase in deferred income tax assets and a
decline in accounts payable. The increase in deferred tax assets was a $24.8
million reduction to cash from operations during the first nine months of fiscal
2002. This deferred tax asset which was generated from pretax losses arising
from charges taken, is targeted to decline over the next several quarters.
Capital expenditures of property, plant and equipment amounted to $28.1 million
during the first nine months of fiscal 2002. In addition, $15.3 million was
invested in available for sale securities and $40.0 million was invested in
securities held to maturity during the third quarter of fiscal 2002. Proceeds of
$57.0 million from securities held to maturity was used to reinvest in available
for sale securities and in securities held to maturity. In addition, $9.1
million was invested in privately held companies.
Cash used in financing activities during the first nine months of fiscal 2002
includes a total of 930,000 shares of common stock which have been repurchased
on the open market for an aggregate of $13.6 million. In addition, we received
$4.3 in proceeds from the exercise of stock options from our employee stock
option plan.
We currently have adequate cash and working capital resources on hand to fund
near term capital expenditures and other planned items. We may issue additional
shares of common stock for the acquisition of complementary businesses or other
significant assets or enter into other capital transactions as needs and
opportunities warrant. From time to time we evaluate potential acquisitions of
and investments in complementary businesses and anticipate continuing to make
such evaluations.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
QUANTITATIVE DISCLOSURES
As of March 24, 2002, the Company maintains investments in publicly traded
equity securities that are treated for accounting purposes under SFAS 115 as
"available for sale" securities. These investments are carried at fair market
value based on quoted market prices of the investments as of March 22, 2002,
with net unrealized gains or losses excluded from earnings and reported as a
separate component of stockholder's equity. These investments are subject to
market risk of equity price changes. Management views these stock holdings as
strategic investments; therefore, the shares are accounted for as "available for
sale" securities under SFAS 115. The fair market value of these investments as
of March 24, 2002, using the closing sale price of March 22, 2002 was $10.5
million.
QUALITATIVE DISCLOSURES
Investments in the common stock of other public companies are subject to the
market risk of equity price changes. While the Company cannot predict or manage
the future market price for such stock, management continues to evaluate its
investment position on an ongoing basis.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
As discussed in the Company's Annual Report on Form 10-K for fiscal year 2001
and its reports on Form 10-Q for the first and second quarters of the current
year, the Company and its subsidiary, Cree Lighting Company, are parties to
certain litigation with Nichia Corporation and its subsidiary, Nichia America
Corporation. The cases previously reported remained pending at the end of the
third quarter.
During the third quarter, in the lawsuit brought by the Company and North
Carolina State University against Nichia and Nichia America in the U.S. District
Court for the Eastern District of North Carolina, Nichia filed a statement in
January 2001 in response to the court's October 2001 order in which the court
directed Nichia to define the trade secrets upon which it based its related
counterclaims against the Company and the part-time Cree Lighting employee named
a co-defendant to the counterclaims. The Company and the Cree Lighting employee
thereafter moved for summary judgment dismissing the trade secret
misappropriation and related claims on the ground that Nichia had failed to
specify any trade secrets that would support the claims; the motion remains
pending. In other developments during the third quarter, Nichia moved to strike
certain of the Company's defenses to Nichia's patent infringement claims and to
preclude the Company from obtaining or using any evidence concerning those
defenses. Nichia alleged in support of its motion that the defenses were based
upon information improperly disclosed by the Cree Lighting employee and
counterclaim co-defendant, which allegations the Company has denied. The court
has not yet ruled on the motion.
In subsequent developments, the court in the same case, in an order entered
March 25, 2002, found that it lacked venue over the counterclaims asserted by
Nichia against Cree Lighting and directed that the counterclaims be transferred
to the U.S. District Court for the Central District of California. The court
also directed the parties to show cause why the remaining trade secret
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misappropriation and related counterclaims should not also be transferred. The
parties filed initial briefs on April 15, 2002 in response to the court's
directive; no ruling has yet been entered. In an order entered April 26, 2002,
the court also dismissed the counterclaims Nichia asserted against the Cree
Lighting employee under the Computer Fraud and Abuse Act, finding that Nichia
had failed to state a claim upon which relief could be granted. In a separate
order entered April 26, 2002, the court also denied a motion by Nichia seeking a
summary judgment on the patent infringement claims of the Company and North
Carolina State University under U.S. Patent No. 6,051,849, which relates to
certain lateral epitaxial overgrowth technology. Nichia had argued that, as a
matter of law, the relevant claims of the patent were invalid on grounds of
indefiniteness
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
The following exhibits are being filed herewith and are
numbered in accordance with Item 601 of Regulation S-K:
99.1 Certain Business Risks and Uncertainties
(b) Reports on Form 8-K:
None.
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned thereunto duly authorized.
CREE, INC.
Date: May 7, 2002 /s/ Cynthia B. Merrell
-----------------------------------------
Cynthia B. Merrell
Chief Financial Officer and Treasurer
(Authorized Officer and Chief
Financial and Accounting Officer)
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