UNITED STATES
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 31, 1997
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 incorporation (IRS Employer
or organization) Identification No.)
2810 Meridian Parkway, Suite 144
Durham, North Carolina 27713
(Address of principal executive offices)
(919)361-5709
(Registrant's telephone number)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. [ X] Yes [ ] No
As of April 14, 1997, 12,400,968 shares of the registrant's common
stock, par value $0.005 per share, were outstanding.
CREE RESEARCH, INC.
FORM 10-Q
INDEX
Page No.
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets at March 31, 1997 (unaudited) and
June 30, 1996 3
Consolidated Statements of Operations for the three and nine months
ended March 31, 1997 and 1996 (unaudited) 4
Consolidated Statements of Cash Flows for the nine months ended
March 31, 1997 and 1996 (unaudited) 5
Notes to Consolidated Financial Statements (unaudited) 7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 12
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 20
Item 6. Exhibits and Reports on Form 8-K 20
Signatures 21
2
Part 1- FINANCIAL INFORMATION
Item 1- Financial Statements
CREE RESEARCH, INC.
CONSOLIDATED BALANCE SHEETS
March 31, June 30,
1997 1996
------------------ ---------------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 8,339,792 $ 10,161,706
Short-term investments, held to maturity - 1,787,271
Accounts receivable, net 7,031,441 6,393,394
Inventories 4,987,151 3,226,484
Prepaid expenses and other current assets 332,799 150,990
------------------ ---------------
Total current assets 20,691,183 21,719,845
Long-term accounts receivable 417,820 464,253
Property and equipment, net 24,196,313 20,218,101
Patent and license rights, net 1,185,046 1,204,738
Other assets 111,853 61,714
Deferred income tax 270,000 -
Goodwill, net 96,690 127,692
------------------ ---------------
Total assets $ 46,968,905 $ 43,796,343
================== ===============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable, trade $ 1,797,087 $2,473,609
Deferred revenue - 17,330
Income taxes payable 250,428 -
Accrued expenses 937,044 633,316
------------------ ---------------
Total current liabilities 2,984,559 3,124,255
Long-term accrued expenses 176,836 -
------------------ ---------------
Total liabilities 3,161,395 3,124,255
Shareholders' equity:
Common stock, $0.005 par value; 14,500,000 shares
authorized; shares issued 12,389,468 and 12,277,418;
net of treasury shares at March 31, 1997
and June 30, 1996, respectively 62,047 61,437
Additional paid-in capital 45,771,841 45,342,063
Accumulated deficit (1,875,875) (4,693,599)
------------------ ---------------
43,958,013 40,709,901
Less: 20,000 and 10,000 shares of common stock in
treasury, at cost, respectively (150,503) (37,813)
------------------ ---------------
Total shareholders' equity 43,807,510 40,672,088
------------------ ---------------
Total liabilities and shareholders' equity $ 46,968,905 $ 43,796,343
================== ===============
The accompanying notes are an integral part of the financial statements.
3
.
CREE RESEARCH, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Three Months Ended Nine Months Ended
March 31, March 31,
------------------------------------ ----------------------------------
1997 1996 1997 1996
-------------- ----------------- --------------- ---------------
Revenues
Product revenue, net $ 5,570,554 $ 2,657,193 $ 12,883,233 $ 6,534,951
Contract revenue 1,394,973 960,558 4,995,592 2,535,461
License fee income - - 2,614,976 1,423,160
-------------- ----------------- --------------- ---------------
Total revenue 6,965,527 3,617,751 20,493,801 10,493,572
Cost of product revenue 3,487,690 1,735,586 8,697,226 5,014,414
Cost of contract revenue 1,244,176 798,768 4,461,573 1,928,521
-------------- ----------------- --------------- ---------------
Gross margin 2,233,661 1,083,397 7,335,002 3,550,637
Operating expenses:
Research and development 484,730 414,832 1,247,481 919,448
Sales, general and administrative 1,079,380 716,076 3,048,730 2,094,440
-------------- ----------------- --------------- ---------------
Income from operations 669,551 (47,511) 3,038,791 536,749
Other income (expense)
Other income (expense) (204,146) (2,502) (383,272) 11,031
Net interest income 138,064 254,356 462,633 682,452
-------------- ----------------- --------------- ---------------
Income before income taxes 603,469 204,343 3,118,152 1,230,232
Provision for income taxes 49,513 - 300,428 10,000
-------------- ----------------- --------------- ---------------
Net income $ 553,956 $ 204,343 $ 2,817,724 $ 1,220,232
============== ================= =============== ===============
Net income per share $ 0.04 $ 0.02 $ 0.22 $ 0.10
============== ================= =============== ===============
Weighted average shares outstanding 13,054,489 13,116,196 13,030,433 12,838,412
============== ================= =============== ===============
The accompanying notes are an integral part of the financial statements.
4
CREE RESEARCH, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Nine Months Ended
March 31,
----------------------------------
1997 1996
----------------- ---------------
Operating activities:
Net income $ 2,817,726 $ 1,220,232
Adjustments to reconcile net income to net cash provided by
(used in) operating activities:
Loss (gain) on disposal of property and equipment 385,559 (11,031)
Depreciation and amortization 2,413,974 1,084,086
Amortization of patent rights 78,809 95,623
Amortization of goodwill 31,002 31,001
Loss on write off of patent applications 129,141 -
Non-cash compensation expense related to stock options - 1,725
Changes in assets and liabilities:
Accounts receivable (591,614) (2,507,210)
Inventories (1,760,667) (1,513,759)
Deferred costs on research contracts - 81,006
Prepaid expenses and other assets (501,948) (156,931)
Accounts payable, trade (910,382) 289,594
Deferred revenue (17,330) -
Accrued expenses and other liabilities 730,992 (21,326)
-------------- ---------------
Net cash provided by (used in) operating activities 2,805,262 (1,406,990)
Investing activities:
Maturity of investment securities 1,787,271 2,110,758
Purchases of property and equipment (6,561,781) (10,467,324)
Proceeds from sale of property and equipment 17,896 51,736
Purchase of patent rights (188,258) (207,390)
----------------- ---------------
Net cash used in investing activities (4,944,872) (8,512,220)
Financing activities:
Repurchase of common stock (112,690) -
Net proceeds from issuance of common stock 430,386 20,795,215
----------------- ----------------
Net cash provided by financing activities 317,696 20,795,215
----------------- ---------------
Net increase (decrease) in cash and cash equivalents (1,821,914) 10,876,005
Cash and cash equivalents:
Beginning of period 10,161,706 3,748,422
----------------- ---------------
End of period $ 8,339,792 $14,624,427
================= ===============
The accompanying notes are an integral part of the financial statements.
5
CREE RESEARCH, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited) - (Continued)
Nine Months Ended
March 31,
----------------------------------
1997 1996
----------------- ---------------
Supplemental disclosure of cash flow information:
Cash paid for interest - $ 5,478
Cash paid for income taxes $ 50,000 -
Supplemental schedule of non-cash investing and financing activities:
Accounts payable recorded for purchases of equipment $233,860 1,638,475
The accompanying notes are an integral part of the financial statements.
6
CREE RESEARCH, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Basis of Presentation
The balance sheet as of March 31, 1997, the statements of operations
for the three and nine month periods ended March 31, 1997 and 1996, and the
statements of cash flows for the nine months ended March 31, 1997 and 1996, have
been prepared by the Company without audit. In the opinion of management, all
adjustments necessary to present fairly the financial position, results of
operations and cash flows at March 31, 1997, and all periods presented, have
been made. The balance sheet at June 30, 1996, has been derived from the audited
financial statements as of that date.
Certain information and footnote disclosures normally included in
financial statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted. It is suggested that these condensed
financial statements be read in conjunction with the financial statements and
notes thereto included in the Company's fiscal 1996 Form 10-K. The results of
operations for the period ended March 31, 1997, are not necessarily indicative
of the operating results that may be attained for the entire fiscal year.
Inventories
Inventories are stated at the lower of cost or market, with cost
determined under the first-in, first-out (FIFO) method. Inventories consist of
the following:
March 31, 1997 June 30, 1996
(000's) (000's)
Raw materials $ 2,117 $1,309
Work-in-progress 1,181 727
Finished goods 1,689 1,190
$4,987 $3,226
Loan Availability
The Company has access to a term loan financing arrangement of up to $4,000,000
to facilitate the purchase of new equipment. The provisions of the loan were
agreed to in October 1996 and the Company had up to six months from that date to
exercise this option. In April 1997, this option was extended until June 1997.
The loan would accrue interest at 8% and would carry customary covenants, namely
the maintenance of a minimum tangible net worth and cash and investment
balances. As of March 31, 1997, there were no outstanding borrowings under this
facility.
7
License Fee Income
On September 30, 1996, the Company entered into a license and
technology transfer agreement and a related supply agreement with Shin-Etsu
Handotai Co. Ltd. ("SEH") and other parties. Pursuant to these agreements, the
Company granted SEH a license to use certain epitaxial and device fabrication
process technology for the manufacture of the Company's blue light-emitting
diode product and has agreed to supply silicon carbide wafers required to
manufacture the licensed product. The license agreement provides for payment of
a license fee and running royalties based on a percentage of sales of products
made using the licensed technology. The license fee is payable in installments.
The first and second installments totaling $1,200,000 were collected during the
second quarter of 1997, an additional payment of $500,000 was collected during
the third quarter of 1997, and two remaining payments of $500,000 are due on
June 30, 1997 and June 30, 1998, respectively. The Company recorded a long-term
accrued expense of $186,000 payable June 30, 1998 to the third party that
brokered the license agreement. Substantially all of the Company's obligations
to transfer the licensed technology were performed at September 30, 1996, and
the net present value of the license fee payments and commission was recognized
at that time.
Research and Development Accounting Policy
The Company partners with the Federal government in many of its current
research and development efforts. By entering into contracts, the Company has
most of its research and product development costs funded by the U.S.
Government. The contract funding may be based on a cost-plus or a cost-share
arrangement. Pursuant to each contract, the amount of funding is determined
based on cost estimates that include direct costs, plus an allocation for
research and development, general and administrative and the 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 funded 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.
Effective January 1, 1997, the Company has reclassified for
accounting purposes some of the funds received from the U.S. Government and
associated direct costs. In previous periods, all funding was reported as
contract revenue and all direct costs were reported as costs of revenue.
Beginning in the third quarter of 1997, the classification is determined based
on the nature of the contract. Contracts the Company anticipates that funding
will exceed direct costs over the life of the contract, are treated in a manner
consistent with prior periods or contracts under which the Company anticipates
that direct costs will exceed amounts to be funded over the life of the
contract,costs will be reported as research and development expenses and related
funding as an offset of those expenses. As a result of this reclassification,
the Company has increased its gross margin. The
8
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 31, March 31,
(000's) (000's)
1997 1996 1997 1996
Net Research & Development costs $ 223 $ 137 $ 432 $ 243
Government funding 663 405 1,427 1,226
Total direct costs incurred $ 886 $ 542 $1,859 $1,469
During the life of these contracts, total direct expenditures and funding are
estimated to be $8,925,000 and $6,857,000, respectively. As of March 31, 1997,
direct expenses and funding of $6,842,000 and $5,494,000, respectively, have
been recognized in connection with these contracts.
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 using the Company's gallium nitride-on-silicon carbide technology.
The original agreement called for shipments from September 1996 through December
1997, however, Siemens was granted the right under certain terms, to defer or
cancel shipments scheduled for the July-December 1997 period. As of February 28,
1997, the Company had shipped all quantities required to be shipped by that date
under the terms of the agreement, plus the quantities originally scheduled for
shipment in March and April 1997.
In March 1997, Siemens and the Company reached an agreement in
principle to amend the Purchase Agreement with respect to shipments to be made
on and after March 1, 1997. Siemens issued purchase orders for its March and
April requirements under the amended terms pending negotiation and execution of
a definitive written amendment, and the parties subsequently executed a
definitive amendment effective April 22, 1997. The amendment provides for
enhanced product specifications requested by Siemens. These specifications
require that all LED's shipped on and after March 1, 1997 be tested to meet a
maximum rating for resistance to electrostatic discharge. In exchange for the
higher grade chip, Siemens agreed to make non-cancelable all shipments scheduled
through September 30, 1997, rather than June 30,1997 as provided in the original
Purchase Agreement. The amendment also limits Siemen's right to defer shipments
to 10% of the scheduled quantities. Additionally, the amendment provides for
higher per unit prices than the corresponding prices in the original Purchase
Agreement and also provides, as did the original agreement, for reductions in
unit prices as the cumulative volume shipped increases. The higher prices were
negotiated by the Company to offset increased per unit costs expected over the
next few months as a result of the enhanced specifications.
9
Revenues received from Siemens for shipments beginning May 1, 1997
are subject to certain foreign currency provisions in the amendment whereby
Siemens will receive discounts if the conversion rate of the German mark to the
U.S. dollar at the date of shipment has averaged 1.75 or more for the preceding
thirty days. As of March 31, 1997, the Company has recognized approximately
$5,100,000 as revenue under this contract.
Income Taxes
The Company has provided an estimated tax provision based upon an
effective rate of 10%. The estimated effective rate was based upon projections
of income for the fiscal year and the Company's ability to utilize existing net
operating loss carryforwards. However, the actual effective rate may vary
depending upon actual pre-tax book income for the year.
Reclassifications
Reclassifications of certain amounts have been made to the June 30,
1996 consolidated balance sheet and the statement of operations for the three
and nine months ended March 31, 1996, and related footnotes disclosure, to
conform to the fiscal 1997 presentation. These reclassifications had no effect
on shareholders' equity, the results of operations or per share data.
Earnings Per Share
The Company will adopt Statement of Financial Accounting Standards
(SFAS) No. 128, "Earnings Per Share", on December 31, 1997. SFAS No. 128
requires the Company to change its method of computing, presenting and
disclosing earnings per share information. Upon adoption, all prior periods data
presented will be restated to conform to the provisions of SFAS No. 128.
If the Company had adopted SFAS No. 128 for the periods ended March
31, 1997, the following computation would have been used to arrive at basic
income per share and diluted income per common share that would have been
presented on the consolidated statements of operations:
10
Three Months Ended Nine Months Ended
March 31, March 31,
------------------------------------ -----------------------------------
1997 1996 1997 1996
----------------- ---------------- ---------------- ---------------
Net income $ 553,956 $ 204,343 $ 2,817,724 $ 1,220,232
Weighted average common shares 12,325,857 12,227,630 12,299,866 11,681,533
----------------- ---------------- ---------------- ---------------
Basic income per common share $ 0.04 $ 0.02 $ 0.23 $ 0.10
================= ================ ================ ===============
Net income $ 553,956 $ 204,343 $ 2,817,724 $ 1,220,232
Weighted average shares:
Common shares outstanding 12,325,857 12,227,630 12,299,866 11,681,533
Dilutive effect stock options &
warrants 728,632 888,566 730,567 1,156,879
----------------- ---------------- ---------------- ---------------
Total shares 13,054,489 13,116,196 13,030,433 12,838,412
Diluted income per share $ 0.04 $ 0.02 $ 0.22 $ 0.10
================= ================ ================ ===============
Contingencies
As reported in its filings on Form 10-Q for the periods ended
September 30 and December 31, 1996, the Company is a defendant in securities
litigation pending before the U.S. District Court for the Middle District of
North Carolina. Certain directors and officers of the Company are also named as
defendants. The litigation was commenced as separate actions filed October 25,
1996, and December 20, 1996, which were subsequently consolidated by order of
the court.
Plaintiffs filed an amended consolidated complaint on March 17,
1997. The claims in the consolidated complaint are substantially the same as
those in the separate complaints previously filed. Plaintiffs seek to represent
a class of all persons who purchased the Company's common stock between February
1, 1996 and July 2, 1996 (the "Class Period"). They assert claims under the
Securities Exchange Act of 1934, as well as claims of negligent
misrepresentation and common law fraud, based upon alleged material
misrepresentations and omissions during the Class Period.
The Company believes that the plaintiffs' allegations are
without merit and intends to defend the cases vigorously.
11
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Cautionary Statements Identifying Important Factors That Could Cause
the Company's Actual Results to Differ From Those Projected in Forward
Looking Statements
In connection with the "safe harbor" provisions of the Private
Securities Litigation Reform Act of 1995, readers of this document are advised
that the document contains both statements of historical facts and forward
looking statements. Forward looking statements are subject to various risks and
uncertainty, which could cause actual results to differ materially from those
indicated by the statements. Examples of forward looking statements include but
are not limited to (i) projections of revenues, income or loss, earnings per
share, capital expenditures, capital structure and other financial items, (ii)
statements of the plans and objectives of the Company or its management or Board
of Directors, including the introduction of new products or methodology or
predictions of actions by customers, suppliers, or competitors, (iii) statements
of future economic performance, and (iv) statements of assumptions underlying
other statements and statements about the Company and its business.
This document also identifies important factors which could cause
actual results to differ materially from those indicated by the forward looking
statements. These risks and uncertainties include the Company's ability to
increase yield and to reduce product unit costs, price competition, other
actions of competitors, infringement of intellectual property rights of the
Company or others, the effects of government regulation, both foreign and
domestic, availability of U.S. government funding for research contracts,
possible delays in the introduction of new products, customer acceptance of
products or services and other factors. Other risks are discussed below in the
section titled "Other Factors Affecting Forward Looking Statements".
The cautionary statements made pursuant to the Private Securities
Litigation Reform Act of 1995 above and elsewhere by the Company should not be
construed as exhaustive or as any admission regarding the adequacy of
disclosures made by the Company prior to the effective date of such Act. Forward
looking statements are beyond the ability of the Company to control and in many
cases the Company cannot predict what factors would cause actual results to
differ materially from those indicated by the forward looking statements.
Results of Operations
The Company's revenues of $6,966,000 for the three month period and
$20,494,000 for the nine months ended March 31, 1997, represent a 93% and 95%
increase over the same periods in fiscal 1996, respectively. Included in the
results for the current nine month period is a one-time net license fee of
$2,615,000. The license fee was earned pursuant to a license and technology
transfer agreement entered into
12
September 30, 1996 with Shin-Etsu Handotai Co. Ltd. ("SEH"). Pursuant to this
agreement, the Company granted SEH a license to use certain expitaxial and
device fabrication process technology for the manufacture of the Company's blue
light-emitting diode ("LED") product. The license fee is payable in
installments. The first and second installments totaling $1,200,000 were
collected in the second quarter of 1997, an additional payment of $500,000 was
collected in the third quarter, and two remaining payments of $500,000 are due
on June 30, 1997 and June 30, 1998, respectively. The Company recorded a
long-term accrued expense of $186,000 payable June 30, 1998 to the third party
that brokered the agreement. Substantially all of the Company's obligations to
transfer the licensed technology were performed at September 30, 1996, and the
net present value of the license fee payments and commission was recognized at
that time. Results for the nine months ended March 31, 1996, included a one-time
net license fee revenue of $1,423,000. This license fee was earned pursuant to a
development license and supply agreement entered into October 25, 1995 with
Siemens A.G. ("Siemens") in which the Company granted Siemens a license to use
certain technology to manufacture blue LED products.
Product revenue increased 110% to $5,571,000 for the quarter ended
March 31, 1997 compared to $2,657,000 for the same period in fiscal 1996.
Product revenue increased 97% to $12,883,000 for the nine month period ended
March 31, 1997, compared to $6,535,000 for the same period in the previous year.
Product revenue is comprised of LED and wafer sales, module display products and
Real Color Displays, Inc ("RCD") moving message sign sales.
LED sales increased 282% for the quarter ended March 31, 1997 as
compared to the same period in the prior year. For the nine months ended March
31, 1997, LED revenue increased 252% as compared to the same period in fiscal
1996.
During the past year, the Company has worked to improve yield and
enhance capacity. Success in these efforts has enabled the Company to increase
the number of LED's produced and shipped during the current fiscal year. The
Company will continue these efforts, as increased output of the DH-85 chip is
considered to be a major factor for the continued growth of the organization .
If the Company fails to continue the current trend of improving yields, it may
be unable to meet its scheduled contract commitments for LED's, or its contracts
may not generate profits for the Company. This would negatively impact margins
for the LED product and may cause the Company to post negative operating
results.
In September 1996, the Company entered into a Purchase Agreement with
Siemens AG ("Siemens"), pursuant to which Siemens agreed to purchase LED chips
made using the Company's gallium nitride-on-silicon carbide technology. The
original agreement called for shipments to be delivered from September 1996
through December 1997, however, Siemens was granted the right under certain
terms, to defer or cancel shipment scheduled for the July-December 1997 period.
As of February 28, 1997, the Company has shipped all quantities required to be
shipped by that date under the terms of
13
the agreement, plus the quantities originally scheduled for shipment in March
and April 1997.
In March 1997, Siemens and the Company reached an agreement in
principle to amend the Purchase Agreement with respect to shipments to be made
on and after March 1, 1997. Siemens issued purchase orders for its March and
April requirements under the amended terms pending negotiation and execution of
a definitive written amendment, and the parties subsequently executed a
definitive amendment effective April 22, 1997. The amendment provides for
enhanced product specifications requested by Siemens. The specifications require
that all LEDs shipped on and after March 1, 1997 be tested to meet a maximum
rating for resistance to electrostatic discharge. In exchange for the higher
grade chip, Siemens agreed to make non-cancelable all shipments scheduled
through September 30, 1997, rather than June 30, 1997 as provided in the
original Purchase Agreement. The amendment also limits Siemens' right to defer
shipments to 10% of the scheduled quantities. Additionally, the amendment
provides for higher per unit prices than the corresponding prices in the
original Purchase Agreement and also provides, as did the original agreement,
for reductions in unit prices as the cumulative volume shipped increases. The
higher prices were negotiated by the Company to offset increased per unit costs
expected over the next few months as a result of the enhanced specifications.
Revenues received from Siemens for shipments beginning May 1,
1997, are subject to certain foreign currency provisions, whereby Siemens will
receive discounts if the conversion rate of the German mark to the U.S. dollar
at the date of shipment has averaged 1.75 or more for the preceding thirty days.
As of March 31, 1997, the Company has recognized approximately $5,100,000 as
revenue under this contract.
The Company is currently focused on obtaining additional LED
customers who are interested in ordering commercial volumes of the product. If
the Company is unable to expand its customer base, its revenue and earnings
growth potential could be adversely impacted.
The Company believes that in order to significantly grow market
demand for the DH-85 product, it must substantially lower prices. To offer lower
pricing to customers, the Company must first reduce unit costs of production.
The planned introduction of a conductive buffer layer chip, currently under
development, is expected to enhance yield output which should allow for a
significant reduction in the manufacturing cost of each chip. If the Company is
unable to manufacture this new chip structure, its ability to reduce costs
appreciably would be impacted. This situation would curtail market development
and growth for the Company's LED business.
Wafer sales have increased 26% for the three months ending March 31,
1997, over the same period in the prior year. Year to date, wafer revenue has
grown 48% over fiscal 1996 results. Additional sales were realized as a result
of greater demand for the
14
Company's SiC wafers and the availability of the product as capacity and yield
improvements have been made.
The module business segment recorded negative revenue of $(374,000) for
the third quarter of 1997. This was caused by the return of a significant sale
made during the first half of the fiscal year, as the product did not meet the
customer's final specifications. Module sales for the nine month period ended
March 31, 1997 were $367,000. Comparatively, module sales recorded in the prior
year were $54,000 and $63,000 for the three and nine month periods ended March
31, 1996, as the product was introduced in that year. Moving message sign sales
by the Company's subsidiary, Real Color Displays, Inc. ("RCD") fell by 44% to
$85,000 during the third quarter of fiscal 1997 as compared to the third quarter
of fiscal 1996. For the nine months ended March 31, 1997, RCD display sign sales
were $358,000 compared to $1,150,000 recorded in the prior year. This
significant reduction in revenue is mainly attributable to a declining interest
from our customer base. Customers are now more interested in specific purpose
static signs. The make up of customers is also changing from small dealers and
distributors to equipment manufacturers.
Research contract revenues increased 45% to $1,395,000 for the three
month period, and 97% to $4,996,000 for the nine month period ended March 31,
1997, as compared to fiscal 1996 results, respectively. This increase is mainly
attributable to management's commitment, and the U.S. Government's partnering
with new funding contracts, to the advancement of silicon carbide and gallium
nitride technology, primarily in microwave, blue laser and basic material
development.
The Company's gross margin was 32% and 36% of revenue for the three and
nine months ended March 31, 1997, respectively. This compares to 30% and 34% for
the same time periods in fiscal 1996, respectively. License fee revenue, which
has no corresponding cost, is included in both nine month period results.
Without license fees, gross margins would have been $4,720,000 or 26% of revenue
for the current nine month period ended March 31, 1997, and 23% of revenue for
the nine month comparative period in fiscal 1996. The overall increase in
margins, net of license fee revenue, results from higher throughput and yield
efficiency on LED and materials products, thereby lowering the cost per unit. To
meet enhanced LED specifications requested by Siemens (discussed above), the
Company expects the cost of revenues to rise for the next few months. In order
to maintain existing margins, the Company has negotiated a higher price per
chip. This higher price will decline over the duration of the contract.
Therefore, if the Company is unable to improve efficiency under the new chip
standards, the results could negatively impact gross margin levels. Also, as a
result of a reclassification of certain contract revenue and cost of revenues to
research and development expense (see Research and Development Accounting Policy
footnote disclosure), gross margin has improved from prior periods.
The Company benefits from research and development efforts sponsored by
both U.S. Government contracts and from internal corporate funding. Contracts
are awarded
15
to the Company to fund both short term and long term research projects. Funding
for projects with near term applications for the Company typically include a
cost-share component that the Company is responsible for absorbing. Projects
that may not have readily available production applications or projects that
relate to longer term development are normally awarded on a cost-plus basis with
built in margins of 7% to 10%.
For financial statement purposes, the reporting of contract activity is
based on the nature of the contract. For contracts under which the Company
anticipates that funding will exceed direct costs, all funding is reported as
revenue and direct costs are reported as cost of revenues. For contracts under
which the Company anticipates that direct costs will exceed funding, costs are
reflected as research and development expenses with related funding amounts
offsetting these costs.
For the nine months ended March 31, 1997, research and development
costs also include a one time write off of $93,000 for the closure of the
Company's Eastern European Division. The Eastern European Division was a basic
research division for some of the Company's material and device development
work.
Sales, general and administrative expenses increased by 51% to
$1,079,000 and 46% to $3,049,000 for the three and nine month periods ending
March 31, 1997, compared to the same periods in fiscal 1996, respectively. For
the quarter, the increase is attributable to overall cost increases to support
the growth of the Company, including recruiting and salary costs for additional
sales personnel to focus the business on gaining new LED customers, and greater
legal fees associated with the defense of the pending securities class action
lawsuit (see Part II, Item 1). Year to date, expenditures are higher than the
prior year due to a combination of the net present value of the $186,000
brokerage fee ($172,000) associated with the license fee revenue recorded in the
first quarter, higher legal fees and other cost increases to support the growth
of the business. The Company expects sales, general and administrative expenses
to continue to increase in future periods as it expands its sales efforts and
due to the pending litigation, which may result in greater legal fees and other
expenses.
Other income (expense) includes disposal costs for fixed assets and
expenses resulting from abandoned patent applications. During the three and nine
month periods ended March 31, 1997, the Company retired fixed assets with net
book values of $207,000 and $386,000, respectively. Much of these retirements
were considered to be a part of a one-time write-down of assets. During the
first quarter of 1997, the Company also retired equipment associated with the
closing of the Eastern European Division. The total write off of this equipment
was $87,000. During the third quarter of 1997, unamortized patent costs were
also reviewed for impairment. This analysis resulted in a $109,000 write-down
for abandoned assets. Finally, during the third quarter of 1997, other income
(expense) was reduced by $123,000, for proceeds received from an insurance
settlement. A claim for business interruption reimbursed the Company for lost
16
first quarter 1997 profits resulting from a temporary plant shut down that was
caused by a natural disaster.
Net interest income decreased $116,000 and $220,000, when comparing the
three and nine month periods ending March 31, 1997 to the three and nine month
periods ending March 31, 1996. This decrease is attributable to lower investable
cash balances available throughout the current periods. The Company concluded a
private equity placement in September, 1995, that increased available cash in
fiscal 1996.
Liquidity and Capital Resources
The Company's cash and current investment balance was $8,340,000 at
March 31, 1997 and $11,949,000 at June 30, 1996. For the first nine months of
fiscal 1997, the Company's operations generated $2,805,000 in cash. For the same
period in fiscal 1996, $1,407,000 was utilized by operations.
The Company invested $6,562,000 in capital equipment during the first
nine months of fiscal 1997 compared to $10,467,000 during the same period in the
prior year. At this time, much of the capital expansion planned for the fiscal
year has been completed. The Company anticipates some additional facilities
spending throughout fiscal 1997, although, a reduction of expenditures is
anticipated over the next several months. The Company has the ability to finance
additional expenditures with cash generated from operations, current available
cash and the availability of a $4 million term loan. On October 17, 1996, the
Company obtained a commitment letter from a bank for this term loan. As of March
31, 1997, there were no outstanding borrowings under this facility.
During the current nine month period, the Company repurchased 10,000
shares of common stock for the treasury for $113,000, and issued shares under
option and warrant agreements for $430,000. The majority of the prior year's
funding was provided by the Company's September 28, 1995, private placement
which netted the Company approximately $17.5 million and funds received in
connection with option and warrant exercises.
The Company expects to continue to finance its operations and capital
expenditures using internally generated funds and possibly from the proceeds of
the term debt facility. However, the Company continually evaluates competitive
conditions in the industry and, as a part of its ongoing strategy, may seek
additional funding sources as market conditions permit.
Other Factors Affecting Forward Looking Statements
Statements in this document and elsewhere that are forward-looking
are subject to a number of risks and uncertainties which could cause actual
results to differ materially, including the following:
17
Since the Company's inception, the Company has derived a significant
portion of its revenue from U.S. Government funded research contracts. Over the
same period, the Company estimates that a substantial part of its product sales
have been made to customers for research purposes. A number of customers are
still evaluating the long term usefulness of the blue LED, and on-going sales of
significant volumes of products cannot be assured. There can also be no
assurance that competitors will not introduce products that are competitive with
or superior to the Company's blue LED.
The Company periodically has experienced lower than anticipated
production yields. Production yield problems in the future could have an adverse
effect on the Company's operations. The Company manufactures several key
components used in its crystal growth and expitaxial deposition processes and
also depends, substantially, on its custom-manufactured processing equipment and
systems. Should the Company experience protracted problems in the production of
its key components or the operation of its proprietary manufacturing systems,
its ability to deliver its products and reduce unit costs to desired levels
could be materially impacted. The Company is also dependent on single or limited
source suppliers for a number of raw materials and components used in its SiC
wafer products and LED's. An interruption in the supply of these items could
cause the Company's manufacturing efforts to be hampered significantly and
result in losses or customer dissatisfaction.
The Company relies on a small number of customers for the majority of
its sales. At present, most of Cree's sales of the DH-85 blue LED chip are to
Siemens pursuant to the parties' Purchase Agreement dated September 6, 1996, as
amended April 22, 1997. This agreement calls for shipments through December
1997, subject to certain cancellation provisions. The cancellation of the
current contract, or the failure to renew this agreement, could have a material
adverse effect on the business and prospects of the Company. Dependence on one
or a few customers may require the Company to agree to unfavorable contract
terms and conditions that could cause contracts to be unprofitable. Likewise,
the failure of the Company to diversify its customer base could limit the
prospects for the blue LED business.
The Company has, and is expected to continue to have, a substantial
percentage of its sales to foreign companies, primarily in Japan, Korea, Taiwan,
China and Europe. There can be no assurance that the Company's current
intellectual property position will be enforceable in foreign countries to the
extent it is enforceable in the United States. In addition, the Company's
international sales may be subject to government controls and other risks,
including export licenses, federal restrictions on the export of technology,
changes in demand resulting from currency fluctuations, political instability,
trade restrictions, changes in tariffs, and collecting accounts receivable.
To remain competitive, the Company must continue to invest substantial
resources in research and development. The Company's prospects for long-term
success are substantially dependent on its ability to continue to increase the
performance of its
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blue LED product and to increase production efficiency. The successful
introduction of the conductive buffer layer chip, which is expected to increase
yield and lower production costs, is very important to the Company achieving its
development goals. Without this implementation, the Company may not maintain or
realize growth in the LED business.
Over the last several years, the Company has been awarded a number of
contracts from agencies of the United States government for purposes of
developing SiC material and SiC-based semiconductor devices. Government policy
is constantly changing, however, and there can be no assurance that the Company
will enter into any additional government contracts or, if such contracts are
entered into, that they will be profitable or produce contract revenues. In
addition, there can be no assurance that after any such contracts are entered
into, changing government regulations will not significantly alter the benefits
of such contracts or arrangements that can be expected to inure to the Company.
Cutbacks in, or reallocations of, federal spending, including changes which
could be proposed or implemented in the future, could have a material, adverse
impact on the Company's results of operations, as well as its ability to
implement its research and development programs.
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PART II - OTHER INFORMATION
Item 1. Legal Proceedings
As reported in its filings on Form 10-Q for the periods ended September
30 and December 31, 1996, the Company is a defendant in securities litigation
pending before the U.S. District Court for the Middle District of North
Carolina. Certain directors and officers of the Company are also named as
defendants. The litigation was commenced as separate actions filed October 25,
1996, and December 20, 1996, which were subsequently consolidated by order of
the court.
Plaintiffs filed an amended consolidated complaint on March 17, 1997.
The claims in the consolidated complaint are substantially the same as those in
the separate complaints previously filed. Plaintiffs seek to represent a class
of all persons who purchased the Company's common stock between February 1, 1996
and July 2, 1996 (the "Class Period"). They assert claims under the Securities
Exchange Act of 1934, as well as claims of negligent misrepresentation and
common law fraud, based upon alleged material misrepresentations and omissions
during the Class Period.
The Company believes that the plaintiffs' allegations are without
merit and intends to defend the cases vigorously.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
Exhibit 10.56: First Amendment to Purchase Agreement, dated as
of April 22, 1997, between the Company and Siemens A.G.
Confidential treatment of portions of this Exhibit is
being requested pursuant to Rule 24 b-2.
Exhibit 11: Computation of Earnings per Share
(b) Reports on Form 8-K:
None.
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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: May 2, 1997 /s/Alan J. Robertson
Alan J. Robertson, Chief
Financial Officer and
Secretary
Date: May 2, 1997 /s/F. Neal Hunter
F. Neal Hunter, President and
Chief Executive Officer
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