UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For The Fiscal Year Ended June 28, 1998
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR
15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ____ to _____
Commission File No. 0-21154
CREE RESEARCH, INC.
(Exact name of registrant as specified in its charter)
North Carolina 56-1572719
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
4600 Silicon Drive, Durham, NC 27703
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (919) 361-5709
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.005 par value
-----------------------------
(Title of Class)
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. Yes [X] No[ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
The aggregate market value of common stock held by non-affiliates of the
registrant as of August 7, 1998 was approximately $149,174,000 (based on the
closing sale price of $14.125 per share).
The number of shares of the registrant's Common Stock, $0.005 par value per
share, outstanding as of August 7, 1998 was 12,991,038.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the definitive Proxy Statement to be delivered to shareholders in
connection with the Annual Meeting of Shareholders to be held November 3, 1998
are incorporated by reference into Part III.
1
CREE RESEARCH, INC
FORM 10-K
For The Fiscal Year Ended June 28, 1998
INDEX
Part I Page
Item 1. Business 3
Item 2. Properties 15
Item 3. Legal Proceedings 16
Item 4. Submission of Matters to a Vote of Security Holders 16
Part II
Item 5 Market for Registrant's Common Equity and Related
Stockholder Matters 16
Item 6. Selected Financial Data 16
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 18
Item 8. Financial Statements and Supplementary Data 24
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosures 45
Part III
Item 10. Directors and Executive Officers of the Registrant 46
Item 11. Executive Compensation 46
Item 12. Security Ownership of Certain Beneficial Owners and
Management 46
Item 13. Certain Relationships and Related Transactions 46
Part IV
Item 14. Exhibits, Financial Statement Schedules and Reports on
Form 8-K 46
Signatures 49
2
PART I
Item 1. Business
General
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Cree Research, Inc. ("Cree" or "the Company"), a North Carolina
corporation, was established in 1987 to commercialize the production of silicon
carbide ("SiC") material and to develop and market SiC-based wafers and devices
and other wide bandgap compound semiconductor products. In December 1987, the
Company acquired an exclusive license to certain technology, developed at North
Carolina State University ("NCSU") relating to silicon carbide, including a
process for bulk growth of single crystalline SiC. The Company has refined and
improved this technology over the past eleven years and is now a world leader in
the design, development, manufacture and marketing of SiC-based semiconductor
materials and electronic devices. The Company incorporates its proprietary
silicon carbide technology to produce compound semiconductors for use in
back-lighting, indicator lamps, displays and other lighting applications. The
Company also manufactures SiC crystals that are sold for use in gemstone
products and SiC wafers that are sold for research directed to optoelectronic,
microwave and power devices. The Company believes that, for certain electronic
applications, SiC-based compound semiconductor devices offer significant
advantages over competing products based on sapphire, silicon, gallium arsenide
and other materials.
The original application of the Company's SiC technology was the
world's first commercially viable blue light-emitting diode ("LED"). The Company
markets its blue LED chip products principally to customers who incorporate them
into packaged lamps for use as indicator lights and in back-lighting
applications, including automotive dashboard instrumentation, cellular handset
products and liquid crystal displays ("LCD"). The LED product is also
incorporated in full color display products used for advertising and in sports
arena video replay boards.
The Company also believes that it supplies much of the worldwide demand
for SiC wafer products to corporate, government, and university laboratories.
These customers utilize the material in the research and development of
optoelectronic devices, including LED products, microwave devices for use in
wireless transmission and digital ultra high frequency ("UHF") broadcast and
high power devices, including power rectifiers and switches, as well as other
applications.
One customer, C3, Inc. ("C3") uses SiC as a gemstone material. The
product is sold in bulk crystal form and then cut, faceted and polished by C3 to
create gemstones with diamond-like characteristics. Physical properties of SiC
are similar to those of diamond as they are both carbon-based minerals with a
similar hardness.
In August 1994, the Company formed a wholly-owned subsidiary, Real
Color Displays, ("RCD"), to develop and market full color LED moving message
displays. As an entry into this business, RCD acquired the assets of a Hong-Kong
based company engaged in the sale of moving message signs. Vertical integration
into the LED display market was seen as a means for the Company to enhance its
core position in LED chip production. RCD's strategy was to target the low-end
full color moving message display market, which is comprised of one and two-line
message signs that display text messages and single graphics, however, these
products have been de-emphasized in recent years. During the second half of
fiscal 1996, Cree introduced a new LED based product, marketed as the "Real
Color Module TM" component, which the Company sells to original equipment
manufacturers ("OEMs") for use in building large area video display systems.
This product has become the primary focus for the future of the Company's
display business.
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The Company performs research directed to developing future products
using SiC, and believes that it leads an advanced study of these devices
worldwide. This research focuses on optoelectronic, microwave and power devices.
A substantial amount of Cree's internal research projects are funded by Federal
government agencies and departments.
The Company's products are manufactured in a manner similar to other
semiconductor materials and devices. Silicon carbide is combined with other
materials and then fabricated into single crystals. The crystals are then sliced
into wafers and polished and either sold as bare wafer material, or processed
for further manufacture. Very thin layers of additional material may be grown on
the bare wafer using a process referred to as epitaxial deposition. Wafers with
these epitaxial layers may be sold outright or used to manufacture other
devices. Wafers that continue for device manufacture are then fabricated in a
clean room environment through various processing steps. The devices fabricated
on the wafer are then tested and cut into chips for sale as LED or other
products.
Description of Business Products
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Blue LEDs
Cree introduced the world's first commercially viable blue LED chip
product in 1989 and has since developed several generations of blue LED
products, including a more robust conductive buffer chip introduced in fiscal
1998 that is brighter, easier to manufacture and has a lower unit cost. Prior to
1989, a blue LED was not readily available as the semiconductor materials used
in red, amber and yellow-green LEDs, are not able to emit blue light. Blue LEDs
offered by others at this time were laboratory samples that could not be
produced in volumes necessary for commercialization. Inexpensive red, amber and
yellow-green LED lamps have been available for more than 20 years and are
used in everyday applications such as indicator lights on printers, computers
and other equipment, and traffic signal lighting for red devices. Groups of
these lights are also used for single or multicolor electronic displays. The
commercial availability of the blue LED, in conjunction with red and green, is
critical to enable the creation of multiple chip lamps and displays capable of
producing any color in the visible spectrum. Combinations of blue, green and red
light in a single cell can create any color light, including white light, making
it possible to create large video displays using LED technology. In addition,
blue LEDs can be used as indicator lamps, in back-lighting and in various other
applications in which red, amber and yellow-green LEDs are used today. LEDs
offer substantial advantages over the small incandescent bulb, including longer
life, lower maintenance and energy consumption and smaller space requirements.
The Company believes that its approach of manufacturing a blue LED
based on a two inch diameter SiC substrate offers a more cost effective design
and process than its competitors, who use a sapphire substrate. The Cree
approach is compact and uses the same top and bottom contact arrangement that is
employed in standard red, amber and yellow-green LED products. Most competitors
place both the positive and negative contact on the top of the diode because the
sapphire substrate material used in their products is not electrically
conductive. Cree's smaller chip design enables the diode to use less material
and permits more devices to be fabricated on each wafer processed. Competitors
offer the blue LED at selling prices higher than the Company's prices. The
Company has been working continuously to reduce the cost of its blue LED chip as
it believes the rate of market acceptance for blue LED products is significantly
dependent on pricing. The Company also anticipates the market for single blue
LED lamps will increase significantly once the pricing of these products is
similar to that of the red, amber and yellow-green LED products available today.
During fiscal 1998, the Company was able to reduce its cost to manufacture an
improved blue LED product by more than 50% through higher throughput, improved
yields, smaller die size, larger wafer size and other attributes of the
conductive buffer process. If the Company can continue this trend, it
4
will allow greater flexibility in pricing to customers in the future. There is
no assurance, however, that the Company will be able to achieve lower costs in
the future or that lower costs will produce increased sales.
Presently, the Company's blue LED chips are primarily used for
back-lighting purposes in automotive dashboard, cellular handsets, LCD displays
and other applications. In addition, they are also used in office equipment
indicator lighting, indoor full-color video display technology, such as stadium
video replay boards, moving message advertising and informational signs.
The Company supplies blue LED chips to LED component manufacturers who
assemble the chip into a lamp and then manufacture solid-state lighting
components to supply to OEMs. The majority of the market for LED-based display
applications is in the Pacific Rim. The Company's principal customers who serve
the display market are located in China, Taiwan and Japan. Cree also sells the
LED product to European and domestic accounts.
Wafer Products
The Company believes that it is the leading manufacturer of
semiconductor quality silicon carbide in the world today. Cree grows its own
crystals using a proprietary process. The crystals are sliced into wafers,
polished and then prepared for the Company's own manufacturing line or for sale
to corporate, government and university programs that are using SiC for the
development of electronic components. Each order may be sold as a bare wafer or
customized by adding epitaxial films, depending upon the nature of the
development program. These customers utilize the material as the basis for
research in optoelectronic, microwave and high power devices. For the past
several years, the Company has worked to improve the quality of its wafers while
increasing the size. The absence of crystal defects is critical to the
development of high power devices in SiC. During fiscal 1998, the Company has
been able to reduce these defects by approximately 50%. Cree is developing two
inch diameter wafers and expects that these wafers will constitute the majority
of material sales during fiscal 1999, although development delays could defer
such sales. This larger sized wafer will replace the 1 3/8 inch product which
comprised the majority of sales in 1998. The larger diameter wafer is expected
to enable lower wafer costs per chip for customers by substantially increasing
the total amount of chips per wafer. The potential market for wafers depends on
whether the Company's customers are successful in creating commercial products
using SiC materials.
Silicon Carbide Crystals for Gemstone Applications
During fiscal 1998, the Company worked under development agreements
with C3. C3 was founded to develop gemstone products from SiC crystals. These
agreements, which were amended and restated in July 1998 as a single agreement,
call for the development of improved processes for the manufacture of near
colorless, large volume silicon carbide crystals for use in lab created gemstone
products. While the focus of this agreement is currently to increase crystal
size and volume, longer term goals include the development of crystals with a
higher color range. The development agreement will enable the Company to perform
further research in the creation of larger volume SiC crystals that may
eventually be employed in other products.
The Company also provides SiC crystals to C3 pursuant to an exclusive
supply agreement. C3 cuts and polishes the product to fabricate diamond-like
gemstones. Recently, C3 has ordered additional crystal grower equipment from
Cree and contracted to increase volume requirements. The potential for
increasing demand depends on Cree's ability to meet C3's requirements for color,
clarity and yield. Future demand is also dependent on C3's ability to cut, facet
and effectively market its gemstone products.
Modules and Moving Message Signs
5
The Company markets a modular LED-based component to customers as a
building block for indoor video and display systems. The product is a low
profile full-color LED sub-assembly for use in both large and small scale
full-color LED display systems. It uses surface mount pixels which combine the
three primary color LED chips which are assembled into very thin modules. The
modules can be combined to form any size display.
Due to the diverse market for LED display systems, the Company cannot
effectively address all opportunities at the display system level and has
therefore chosen a strategy of supplying modules directly to well established
LED display system suppliers. This approach maximizes the efficiency of the
Company's sales resources, minimizes the capital investments that would need to
be made as a systems supplier, and does not place the Company in competition
with potential display system customers.
The Company's RCD subsidiary has been manufacturing full color moving
message sign products since its inception in August 1994. The Company is able to
produce a variety of color moving message products. The sign products range in
brightness from indoor to high-bright, which is suitable for store window
applications. These products provide a low cost and effective way of displaying
text messages which can be easily changed and updated. The applications for
these displays include point-of-sale advertising and informational signs.
The Company is currently reviewing the business plans for both of these
product lines to maximize sales for fiscal 1999. The Company is developing a
brighter blue and pure green LED product which is expected to be introduced
during fiscal 1999, although development delays could defer the product
introduction. The new LEDs are expected to provide the display business a low
cost, high performance product suitable for outdoor applications. This
expected upgrade in technology is anticipated to change market opportunities for
these products.
Product Development
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The Company is engaged in a number of research and development
projects. Some projects have the goal of developing commercial products for the
market in the near term. Other projects have longer term goals. There can be no
assurance as to the successful development of commercial products or the timing
thereof. All of the products under development are based on SiC materials grown
using the Company's proprietary processes.
The Company partners with the Federal government in many of its current
research and development efforts. Contracts are awarded 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 arrangement.
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 exceeding 5%. 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 costs, and a
cost of capital expense. 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. The
contracts typically require the submission of a written report to document the
results of such research. The government may terminate contracts with the
Company at its convenience and typically obtains a nonexclusive license to use
any inventions made in the course of the research solely for government
purposes.
6
For financial reporting purposes, the Company includes funding for all
cost-plus and cost-share contracts, where the Company anticipates that total
funding will exceed direct costs over the life of the contract, as contract
revenue. All associated direct costs for these contracts are reported as a cost
of contract revenue. For cost-share contracts where the Company anticipates that
costs will exceed funding over the life of the contract, funding is reflected as
a reduction of research and development expenses, while the associated direct
costs are reported as research and development expenses. During fiscal years
1998, 1997 and 1996, the Company spent $8,474,000, $9,411,000, and $5,572,000,
respectively, for direct expenditures relating to product research and
development activities. During the same periods, the U.S Government funded
$8,241,000, $8,760,000 and $5,721,000, respectively, for direct and indirect
expenses. In addition, customers have also sponsored research activities
relating to the development of new products. During fiscal years 1998 and 1997,
customers spent $3,477,000 and $66,000, respectively, for product research and
development activities. In fiscal 1996, customers did not provide significant
funding for research activities. The Company expects to continue to perform
substantial research and product development projects during the next fiscal
year.
The following applications are currently under research and development
by the Company. The Company expects several of these applications to be
completed in fiscal 1999, although delays could occur. Other development
projects, such as power devices and blue laser research are not expected to
produce commercial results until later years.
Silicon Carbide Material
The Company continually conducts research aimed at improving the
quality of its wafers and enhancing its epitaxial (active layer) process. The
Company believes it can increase the diameter of its wafers while lowering
manufacturing costs and permitting the development of more complex devices. The
key determinant that will enable the manufacture of a more complex device, such
as power semiconductors, is the substrate quality and wafer size. Epitaxial
thickness, lower defect density and the elimination of variation are important
factors to improve yield, marketability and lower cost. The larger two inch
wafer size, which the Company expects will comprise the majority of fiscal 1999
wafer sales, is considered a minimum standard for many niche fabrication
facilities. The Company continues work on a $7.6 million contract awarded by the
Defense Advanced Research Projects Agency ("DARPA") to fund this research and
development. The contract has $1,702,000 in funds remaining and extends through
May 1999.
Lower Cost Blue LED Chips
In fiscal 1998, Cree developed a blue LED that was brighter than its
prior generation blue LED. The brighter chip was developed by using a new
process that allows a chip design in which current flows vertically through the
device. This design, which is currently manufactured on a two inch wafer, yields
more chips per wafer and requires fewer manufacturing steps; therefore, it is
produced at a lower cost.
In order for the product to approach the acceptance and marketability
of red, amber and yellow-green LEDs, the Company's management believes the price
of the chip must be further reduced. In order to reduce the cost of production,
the Company must attain success in increasing volume throughput by expanding the
customer base, and develop additional manufacturing yield improvements. These
modifications are expected to significantly reduce unit costs by improving the
die per wafer yield and spreading fixed costs over more units. There can be no
assurance that these goals will be achieved. If the Company does not achieve
sufficient increases in yields and volume throughput, then costs would fail to
decline significantly and the Company's ability to generate higher margins or to
maintain margins while reducing chip prices would be impaired.
Brighter Blue and Green LED Chips
7
The Company is working to develop brighter blue and green LEDs
that would be cost-effective for outdoor applications. This design employs
indium gallium nitride layers on silicon carbide. The current generation of the
Company's blue LED products are primarily used in indoor applications, as the
brightness of the product is not as high as some competing products. The Company
believes that this chip will open new markets with a low cost platform. Cree is
also developing two new green LED products that employ the same technology as
the new brighter blue offering. These products are expected to be suitable for
the outdoor LED display market and for traffic signal applications,
respectively. Samples of these new products are expected to be released in the
first quarter of fiscal 1999, although introduction could be delayed by
unforeseen development problems.
High-Power Radio Frequency and Microwave Transistors
The Company is currently developing high-power transistors that operate
at radio and microwave frequencies. Such devices could have important
applications in cellular phone base stations, high-power solid-state broadcast
systems for television and radio, and radar search and detection equipment.
The Company also continues development of a SiC-based device which is
designed for use in base stations for wireless systems. This device, which is
not expected to be released commercially before late fiscal 1999, can be used
for frequency band applications above 1.8 gigahertz, such as the personal
communications system ("PCS") base station network currently being installed by
some wireless carriers. The Company believes that silicon carbide transistors
will be superior to current silicon and gallium arsenide devices due to greater
power per transistor. The higher output power available from SiC devices is
expected to allow wireless systems to use fewer transistors per base station and
less complex circuitry, at a lower cost. This power density is four to five
times higher than that achieved with equivalent silicon or gallium arsenide
devices. In addition, SiC's ability to dissipate heat more rapidly than other
materials reduces the need for costly cooling equipment. In March 1998, the
Company demonstrated a device with 53 watts of power from a single chip. Cree
expects to offer a product that emits 75-100 watts of power from a single chip
in order to reach commercial viability. During fiscal 1998, the Company
continued to work on several contracts from Naval Research Laboratories, DARPA,
and the Army Research Laboratories to advance this research. These contracts
extend through August 1999.
During fiscal 1998, the Company reported the demonstration of gallium
nitride on SiC transistors that, although low in total output power, operate at
a power density of 6.8 watts per millimeter at 10 gigahertz. This power density
is the highest ever reported for a solid state field effect transistor operating
at radio or microwave frequency and is eight times higher than that achieved
with equivalent silicon or gallium arsenide devices. A commercial device capable
of emitting power at this level is not expected during the next fiscal year.
Blue and Ultraviolet ("UV") Laser Diodes
The storage capacity of optical disk drives can be increased
significantly by utilizing a laser diode capable of emitting short wavelength
light. The Company has demonstrated a laser diode fabricated from indium gallium
nitride and related materials deposited on SiC substrates that emits a shorter
wavelength blue light than that of the red or infrared lasers used today. This
technology could potentially increase the storage capability of optical disk
drives by a factor of four to five. This increased storage capability could lead
to advances in CD-ROM data storage and audio and video compact disc
applications.
Government funds were last allocated to development of the blue laser
diode in June of 1996 when DARPA awarded a $4.3 million contract to the Company
to be spent over a three year period. Most of these funds have now been
exhausted. As a part of this development, in July 1997 the Company announced
that it
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had demonstrated a continuous wave laser operation at room temperature.
Substantial work is still needed to produce a blue laser suitable for commercial
application. There can be no assurance that a commercial product will result
from this research and development effort.
High-Power Semiconductors
The Company is working on the development of prototype high power
devices that, if successfully developed, could have many significant uses. Such
devices could be employed in applications involving power conditioning as well
as switching power to allow electricity to flow to other electronic components.
SiC based power devices have the potential to handle up to fifty times more
power density than current silicon based devices. SiC devices are expected to
operate at significantly higher temperatures and voltages, have superior
switching capabilities, yet retain a die size almost twenty times smaller than a
silicon based device. Potential applications include power drive components for
electric vehicles, lighting ballast components, industrial motor controls, and
power supplies with minimal interruption used in power transmission. These power
devices are not anticipated to be commercially available during the next fiscal
year.
The Company recently entered into a three year, up to $3 million,
project with Kansai Power Electric Company, the fourth largest power company in
the world, for research in switching systems in power transmission networks. The
Company continues to make progress in improving the quality of its SiC material,
improving processes for fabricating devices and improving device designs.
However, there is no assurance that further work will result in improvements in
processes, material quality and end products that are necessary to introduce
such products to market. Also, it is anticipated that the Company will need to
develop methods to reliably produce wafers of a three inch or greater diameter
in order to make such devices economically viable. There can be no assurance
that this will be accomplished. The Company continues to work under contracts
with the government and other sources for research in this area. Work is
currently being performed for the Office of Naval Research and other sources.
These contracts extend through September 2000.
Gemstone Applications
During fiscal 1998, the Company worked under development agreements
with C3. These agreements, which were amended and restated in July 1998 as a
single agreement, call for the development of improved processes for the
manufacture of colorless, large volume silicon carbide crystals for use in lab
created gemstone products. The agreement obligates C3 to pay Cree's direct costs
of the development effort, plus an overhead charge on certain costs. Work to be
performed under this contract during the next year will target the development
of larger sized crystals and is expected to result in a three inch diameter
crystal for possible use in other product applications.
High-Temperature Devices
The Company has developed prototype SiC-based transistors and
rectifiers that operate at higher temperatures than comparable silicon devices.
These high-temperature semiconductors have potential applications in the
automotive, energy and aerospace industries. For example, these devices could be
used to amplify low level sensor signals directly on the engine block of an
automobile engine to measure engine performance. This allows the optimization of
fuel economy by adjusting engine performance during operation. In addition,
these devices could find use in applications such as down hole drilling
equipment and space-based power systems. Although prototype devices have been
developed, additional development work is needed to achieve commercial
viability. Work is currently being performed for the Defense Special Weapons
Agency and other sources.
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9
Strategic Alliances
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The Company believes that the formation of strategic alliances with
other companies is a viable strategy for the immediate development of its
technology to bring certain products to market.
Cree and Siemens A.G. ("Siemens") entered into a Development, License
and Supply Agreement in fiscal 1996 to work jointly on the development of a
green LED on silicon carbide substrates, as well as improvements to Cree's blue
LED product. Siemens is a manufacturer of LED lamps for its merchant components
business. In addition to undertaking the joint development program, Siemens paid
a $1.5 million license fee to license certain epitaxial and fabrication
technology from Cree for use in the manufacture of green and blue LEDs. The
agreement also includes provisions under which Cree will supply a portion of
Siemens' requirements for blue and green LEDs and wafer products required for
the manufacture of such LEDs. In September 1996, the Company entered into a
Purchase Agreement with Siemens, pursuant to which Siemens agreed to purchase
blue LED chips made using the Company's gallium nitride-on-silicon carbide
technology. In December 1997, the Purchase Agreement was amended to provide for
additional shipments of LED products through December 1998. The Company is
currently negotiating an extension of this agreement with Siemens.
Also, in September 1996, the Company entered into a License and
Technology Transfer Agreement and a related Supply Agreement with Shin-Etsu
Handotai Co. Ltd. ("Shin-Etsu") and other parties. Pursuant to these agreements,
the Company granted Shin-Etsu a license to use certain epitaxial and device
fabrication process technology for the manufacture of the Company's blue LED
product and agreed to supply silicon carbide wafers required to manufacture the
licensed product. The license agreement provided for a payment of a $2.6 million
license fee and royalties based on a percentage of sales of products
made using the licensed technology.
Sales and Distribution
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The Company markets its blue LED chips domestically and in a number of
foreign countries. Because the production of lamp and display products
incorporating LED chips is concentrated among a relatively small number of
manufacturers, the Company uses an executive sales approach to market its LED
chips. In Japan the Company markets its LED products and SiC wafers through its
distributors Sumitomo Corporation and Shin-Etsu Handotai Co., Ltd. pursuant to a
Distributorship Agreement signed in 1995. The Company markets its LED and SiC
wafer products throughout the rest of the world via a small direct sales staff.
The Company currently distributes the majority of its LED-based modules
directly to OEMs. The OEMs in turn manufacture, sell and generally install
modular based display systems at their customers' sites.
The majority of moving message signs are sold through the Company's
subsidiary, RCD, via a network of international distributors and sales
representatives in South America, the United Kingdom, the Pacific Rim and
Canada. RCD also employs a direct sales program and uses a dealer network to
market a portion of its products in the United States.
The Company also sells SiC crystal materials for use in gemstone
applications directly to C3 under an exclusive supply agreement.
Competition
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10
The semiconductor industry is intensely competitive and is
characterized by rapid technological change, price erosion, and intense foreign
competition. The Company believes that it currently enjoys a favorable position
in the existing and potential emerging markets for SiC-based products and
materials primarily as a result of its proprietary SiC-based technology.
However, the Company faces actual and potential competition from a number of
established domestic and international compound semiconductor companies. Many of
these companies have greater engineering, manufacturing, marketing, and
financial capabilities than the Company.
The Company's primary competition for the blue LED product comes from
Nichia Chemical Industries, Ltd. ("Nichia") and Toyoda Gosei Co. Ltd.
("Toyoda"), companies headquartered in Japan, and from The Hewlett-Packard
Company ("HP"), who currently market blue LED products that are brighter than
the Company's LED device. The sales price for Cree's LED is presently lower than
the standard price of the product offered by these companies. However, there can
be no assurance that these companies will not offer lower pricing in the future.
Cree's LED product is made by growing epitaxial layers on SiC
substrates for the subsequent fabrication of the blue LED. Competing blue LED
products employ a sapphire substrate. Cree's vertical chip has a lower cost
primarily as a result of its size. Cree's chip has a surface area that is 57% of
the size of the current competitive chip. Thus, SiC substrates can be more
expensive than sapphire and still be competitive on a price per chip basis. The
sapphire substrate requires a larger chip because sapphire is an insulator
material, and as such, requires a horizontal device with both contact points at
the top of the device. The Cree SiC product is a conductive substrate, which
allows one contact point on the top and the other on the bottom, allowing for a
smaller vertical device. Furthermore, because red, amber and yellow-green chips
are vertical devices, Cree's vertical structure facilitates easier use in
existing LED component assembly operations.
The ability of the Company to compete successfully in existing and
future markets for its products will depend on factors both within and outside
its control. These factors include, but are not limited to, success in
manufacturing new higher brightness SiC based products that are suitable for
outdoor applications, improvements to existing products, improvements in its
SiC-based process technology, increasing production capacity of LED products,
protection of its products by effective utilization of intellectual property
laws, diversity of product line, the rate at which customers incorporate the
Company's components into their products, product introductions by the Company's
competitors, and general domestic and international economic conditions. The
Company; however, expects that price will be a determining factor for many of
its products and it devotes substantial efforts to reduce production costs (See
"Product Development"). There is no assurance that the Company's competitive
position will not be adversely affected by one or more of these factors in the
future, particularly in view of the fast pace of technological change in the
semiconductor industry.
Sources and Availability of Raw Materials
- --------------------------------------------------------------------------------
The Company depends on single or limited source of suppliers for a
number of raw materials and components used in its SiC wafer products and LEDs,
including certain key materials and equipment used in its crystal growth,
wafering, polishing, epitaxial deposition, device fabrication, and device test
processes. The Company generally purchases these single or limited source
materials and components pursuant to
11
purchase orders and has no guaranteed supply arrangements with such suppliers.
In addition, the availability of these materials and components to the Company
is dependent, in part, on the Company's ability to provide its suppliers with
accurate forecasts of its future requirements. Production of many materials used
in semiconductor manufacturing is limited to one or a few manufacturing
facilities worldwide. Disruption of production at one or more of these
facilities represents a risk for the entire semiconductor industry. However,
smaller companies, such as Cree, may be at greater risk than larger companies if
supplies of any materials become scarce as suppliers may favor their larger
customers in allocating their products. Any interruption in the supply of these
key materials or components could have a significant adverse effect on the
Company's operations.
Customers
- --------------------------------------------------------------------------------
During fiscal 1998, sales to Siemens A.G. accounted for more than 10%
of total revenue. The loss of Siemens' business would have a material adverse
effect on the results of operations if the Company were unable to replace the
volume with another customer. In addition, sales to C3, Inc. and the Department
of Defense each comprised more than 10% of total Company revenue for fiscal
1998. For the year ended June 30, 1997, revenue from Siemens and the Department
of Defense each accounted for more than 10% of total revenue. For the year ended
June 30, 1996, Siemens, Sumitomo and the Department of Defense revenues each
accounted for more than 10% of total revenue.
Backlog
- --------------------------------------------------------------------------------
As of June 28, 1998, the Company had a firm backlog of approximately
$12.6 million consisting of approximately $7.2 million of product orders and
$5.4 million of executed research contracts with the U.S. Government. This
compares to a firm backlog level of $17.5 million as of June 30, 1997, which
consisted of approximately $9.2 million of product orders and approximately $8.3
million of executed research contracts with the U.S. Government.
Patents and Proprietary Rights
- --------------------------------------------------------------------------------
The Company has an exclusive license to ten U.S. patents from North
Carolina State University ("NCSU"), and holds 40 additional domestic patents of
its own or owned jointly. Cree licensed 12 foreign patents issued on the same
NCSU technology and holds 19 foreign patents issued on Cree applications which
are counterparts to the U.S. patents. The Company also holds exclusive license
rights to inventions owned by NCSU which are subject to one pending U.S. patent
application and two foreign applications, which are counterparts of the U.S.
patent applications. Cree has 27 patent applications of its own pending in the
United States and also has 79 foreign patent applications pending. In addition
to its patent rights, the Company relies upon certain proprietary know-how and
trade secrets in its manufacturing process and has entered into non-disclosure
agreements to protect its proprietary technology with both employees and parties
outside of the Company.
The Company earns a material amount of its revenues in overseas
markets. See "Customers". While the Company has applied for patent protection
for certain of its technologies and products in some of these markets, there can
be no assurance that such markets will be subject to the Company's intellectual
property rights.
12
The NCSU License. In 1987, the Company entered into a license agreement
with NCSU pursuant to which the Company was granted a worldwide, fully paid,
exclusive license to manufacture, use, and sell products and processes covered
by the claims of ten U.S. patent applications filed by NCSU relating to SiC
materials and SiC-based semiconductor devices, some of which also have been
filed in foreign countries. Ten patents were subsequently issued with respect to
eight of those applications, with expiration dates between 2007 and 2009. Twelve
of the foreign filings have been issued with expiration dates from 2006 through
2012. Under the terms of the license, the U.S. Office of Naval Research has
retained an interest in the licensed technology for certain military
applications.
Cree's Patents. Since its inception, the Company has been granted 40
U.S. patents of its own or jointly owned. These patents expire between 2008 and
2016. The Company has filed a number of these patent applications in foreign
countries, 17 of which have been issued. In addition, the Company has, in
the past, entered into joint research and development programs to develop new
SiC-based devices. These efforts have resulted in four jointly-owned patents,
one with Purdue University, two joint patents with General Electric Corporation,
and one joint patent with NCSU.
Although the Company has not received any claims that its products
infringe on the proprietary rights of third parties, there can be no assurance
that third parties will not assert infringement claims against the Company in
the future with respect to current or future products or that such assertion may
not require the Company to enter into royalty arrangements, prevent the Company
from selling products, or result in protracted or costly litigation.
Because of rapid technological developments in the semiconductor
industry and the broad and rapidly developing field of patent law, the patent
position of any semiconductor device manufacturer, including that of the
Company, is subject to uncertainties and may involve complex legal and factual
issues. Consequently, although the Company holds certain patents, is licensed
under other patents, and is currently pursuing additional patent applications,
there can be no assurance that patents will be issued from any pending
applications or that claims allowed by any existing or future patents issued or
licensed to the Company will not be challenged, invalidated, or circumvented, or
that any rights granted thereunder will provide adequate protection to the
Company. Moreover, the Company may be required to participate in interference
proceedings to determine the priority of inventions, which could result in
substantial costs to the Company.
Environmental Regulation
- --------------------------------------------------------------------------------
The Company uses and disposes of hazardous substances and wastes in its
manufacturing and research and development activities and is thus subject to a
variety of federal, state and local government laws and regulations related to
the storage, use and disposal of such materials. The Company is also subject to
laws and regulations related to the discharge of environmental pollutants. The
Company believes that it is in compliance with all applicable laws regulating
hazardous materials and environmental pollutants and is not presently aware of
any contamination at any of its premises for which it could be responsible under
applicable law. However, the failure to comply with present or future laws or
regulations relating to such materials could result in fines or other
liabilities being imposed on the Company, or in suspension or cessation of
operations, which events could have a material adverse effect on the Company's
business and prospects.
Employees
- --------------------------------------------------------------------------------
13
As of June 28, 1998, the Company employed 248 people, all of which are
located in the United States. None of the Company's employees are represented by
a labor union or subject to collective bargaining agreements. The Company
believes relations with its employees are strong.
Risk Factors
- --------------------------------------------------------------------------------
Ownership of the Company's securities is subject to a number of risks,
including the following:
Production Efficiency and Availability of Raw Materials
The Company must continue to improve its production yields in order to
reduce costs. Production yield problems or missed efficiencies may have an
adverse effect on the Company's operations. 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 could
be materially impacted. Such problems often occur as new products are introduced
or improvements are made to existing products. As the Company expects several
significant development projects to be completed in fiscal 1999, the Company may
be particularly vulnerable to this risk. The Company is also dependent on a
limited source of suppliers for a number of raw materials and components used in
its SiC wafer products and LEDs. An interruption in the supply of these items
could cause the Company's manufacturing efforts to be damaged and result in
customer dissatisfaction.
Concentration of Business
The Company relies on a small number of customers for much of its
sales. At present, the majority of the LED sales are made to Siemens pursuant to
the parties' Purchase Agreement executed in September 1996 and amended in
December 1997. This agreement calls for shipments through December 1998, subject
to certain rescheduling provisions. Failure to extend 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 LED business.
Foreign Sales
The Company has, and is expected to continue to have, a substantial
percentage of its sales to foreign companies, primarily in Asia 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, changes in demand resulting from currency
fluctuations, political instability, trade restrictions, changes in tariffs and
collection of accounts receivable. If the current slowdown in the economies of
certain Asian countries worsens, the Company may be materially adversely
affected.
Research and Development
To remain competitive, the Company must continue to invest substantial
resources in research and development. The Company's prospects for both
near-term and long-term success are substantially dependent on its ability to
continue to increase the performance of its LED products and to increase
production efficiency. The successful introduction of the brighter blue and
green products and the expected
14
higher yield and lower costs of the conductive buffer product, is very important
for the Company to achieve its goals for fiscal 1999. Furthering the need for
enhanced efficiency, is the expected decline in the average sales price for the
LED products in fiscal 1999. Without the introduction of the brighter LED
products and yield and volume efficiencies of the conductive product, the
Company may not maintain or realize growth in the LED business. In addition, the
Company must also invest resources toward the introduction of microwave products
in fiscal 1999. See "Product Development". Near-term results may suffer due to a
lag between investment in development, marketing and production, and revenues
derived from the investment even if new or improved products are a long-term
success.
The patents and other proprietary rights of the Company may not
prevent the competitors of the Company from developing noninfringing technology
and products that are more attractive to customers than the technology and
products of the Company. The technology and products of the Company could be
determined to infringe the patents or other proprietary rights of others. In
addition, defending such an infringement claim could have a material adverse
impact on the Company even if the claim were found to lack merit.
Dependence on Contracts With the U.S. Government
Over the past 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, therefore, 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 revenue. 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 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.
Item 2. Description of Property
The Company purchased real property consisting of approximately 30
acres of land on which exists a 162,000 square foot production facility and a
total of 35,000 square feet of service and warehouse buildings. This property is
located in Durham County, North Carolina, in the vicinity of the Research
Triangle Park. The purchase price for the land and buildings was $3 million.
Since the acquisition of this facility, the Company has invested approximately
$8.4 million in building upfits and improvements. The Company plans to relocate
the majority of its operations to this facility over the next few years.
The Company currently leases space for its manufacturing and primary
research and development facilities, which occupy 21,900, 1,900 and 1,900 square
feet, respectively, in the same building in Durham, North Carolina. The leases
expire in December 2001, May 1999 and October 1998, respectively. In addition,
the Company also leases approximately 13,200 square feet in a separate building
in Durham, North Carolina, for its device fabrication and test processes. This
lease term expires in August 2000.
Item 3. Legal Proceedings
The Company is not a party to any material litigation and is not aware
of any pending or threatened litigation that could have a material adverse
effect either upon the Company's business, operating results or financial
condition.
Item 4. Submission of Matters to a Vote of Security Holders
15
No matters were submitted to a vote of security holders during the
fourth quarter of fiscal 1998.
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
Common Stock Market Information. The Company's common stock is traded
in the NASDAQ National Market System and is quoted under the symbol "CREE". The
following table sets forth, for the quarters indicated, the high and low bid
prices as reported by NASDAQ. Quotations represent interdealer prices without an
adjustment for retail markups, markdowns or commissions and may not represent
actual transactions.
FY 1998 FY 1997
High Low High Low
---- --- ---- ---
First Quarter $20-1/2 $11-3/4 $15-3/4 $8-1/4
Second Quarter $29-1/5 $15-5/8 $14 $8-7/8
Third Quarter $19-5/8 $13-1/2 $15-7/8 $9-3/8
Fourth Quarter $17-5/8 $14 $15-1/8 $9-1/2
Holders and Dividends. There were approximately 381 holders of record
of the Company's Common Stock as of August 7, 1998.
The Company has never paid cash dividends on its Common Stock and does
not anticipate that it will do so in the foreseeable future. There are no
contractual restrictions in place that currently materially limit, or are likely
in the future to materially limit, the Company from paying dividends on its
common stock, but applicable state law may limit the payment of dividends. The
present policy of the Company is to retain earnings, if any, to provide funds
for the operation and expansion of its business.
Item 6. Selected Financial Data
The consolidated statement of operations data set forth below with
respect to the years ended June 28, 1998, and June 30, 1997 and 1996, and the
consolidated balance sheet data at June 28, 1998 and June 30, 1997 are derived
from, and are qualified by reference to, the audited consolidated financial
statements included elsewhere in this report and should be read in conjunction
with those financial statements and notes thereto. The consolidated statement of
operations data for the years ended June 30, 1995 and 1994 and the consolidated
balance sheet data at June 30, 1996, 1995 and 1994 are derived from audited
consolidated financial statements not included herein.
16
Selected Financial Data
(in thousands, except per share data)
Years Ended
-----------------------------------------------------------
June 28, June 30, June 30, June 30, June 30,
1998 1997 1996 1995 1994
-------- -------- -------- -------- --------
Statement of Operations Data:
Product revenue, net $ 34,891 $ 19,823 $ 9,689 $ 5,989 $ 3,534
Contract revenue, net 7,640 6,535 3,945 3,011 3,956
License fee income -- 2,615 1,423 -- --
-------- -------- -------- -------- --------
Total revenue 42,531 28,973 15,057 9,000 7,490
Net income (loss) from continuing operations 6,275 3,542 243 (17) (431)
Basic earnings (loss) per common share $ 0.49 $ 0.28 $ 0.02 $ 0.00 $ (0.04)
Dilutive earnings (loss) per common share $ 0.47 $ 0.27 $ 0.02 $ 0.00 $ (0.04)
Weighted average shares outstanding 13,493 13,126 12,615 10,367 10,337
Years Ended
-----------------------------------------------------------
June 28, June 30, June 30, June 30, June 30,
1998 1997 1996 1995 1994
-------- -------- -------- -------- --------
Balance Sheet Data:
Working Capital $ 27,603 $ 21,013 $ 18,596 $ 9,971 $ 11,006
Total assets 72,724 50,137 43,796 20,924 20,018
Long-term obligations 10,804 1,638 -- -- 14
Shareholders' equity $ 54,865 $ 45,125 $ 40,672 $ 19,504 $ 19,334
* The Company has not declared a dividend on common stock since its inception
** The years ended June 28, 1998 and June 30, 1997, 1996 and 1995 include the
Company's wholly owned subsidiary, Real Color Displays, Inc.
17
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Cautionary Statement Identifying Important Factors That Could Cause the
Company's Actual Results to Differ From Those Projected in Forward Looking
Statements
Pursuant to the "safe harbor" provisions of the Private Securities
Litigation Reform Act of 1995, readers of this report are advised that this
document contains both statements of historical facts and forward looking
statements. Forward looking statements are subject to certain risks and
uncertainties, which could cause actual results to differ materially from those
indicated by the forward looking statements. Examples of forward looking
statements include, but are not limited to (i) projections of revenues, income
or loss, earnings per share, capital expenditures, dividends, capital structure
and other financial items, (ii) statements of the plans and objectives of the
Company or its management or Board of Directors, including product enhancements,
or estimates or predictions of actions by customers, suppliers, competitors or
regulatory authorities, (iii) statements of future economic performance, and
(iv) statements of assumptions underlying other statements and statements about
the Company and its business.
This report 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
complete development of and successfully introduce new LED and microwave
products, to lower LED and wafer costs, to gain a larger customer base, and to
increase product yields and wafer size, possible price competition, potential
failure to obtain expected volume increases from existing customers, potential
infringement claims by third parties, potential inability of the Company to
enforce its intellectual property rights against others, availability and
continuation of U.S. government funded research contracts, possible delays in
the introduction of other new products, and delays in customer acceptance of
products or services and other factors, which are described herein. See Item 1,
Business, Risk Factors.
On September 24, 1997, the Board of Directors of Cree Research, Inc.
changed the Company's fiscal year from the twelve months ending June 30, to a 52
or 53 week year ending on the last Sunday in the month of June. The Company's
1998 fiscal year extended for the period from July 1, 1997 to June 28, 1998.
Results of Operations
For the fiscal year ended June 28, 1998, Cree posted record revenue and
net income of $42,531,000 and $6,275,000, or $0.47 per diluted share,
respectively. These results reflect an increase in revenue and net income of
$13,558,000 and $2,733,000, respectively, over the prior year. Product revenue,
which includes LED, wafer and other material sales, module display products and
moving message sign sales, reflects a 76% increase over fiscal 1997 results.
Comparatively, product revenue also increased 105% during fiscal 1997 over 1996
amounts.
Product Revenue
During fiscal 1998, a significant portion of the rise in product
revenue was directly attributable to the 132% increase in blue light-emitting
diode ("LED") volume pursuant to an amendment to a purchase agreement signed in
September 1996 with Siemens A.G. ("Siemens"). That agreement and two subsequent
amendments, provided for $6.8 million in additional sales to Siemens in fiscal
1998 over 1997. As amended, the agreement presently obligates Siemens to
purchase certain quantities of LED products through December 1998. Additionally,
the amendment provides for higher prices per unit on items shipped early in the
contract, with unit prices being reduced as volume increases in the latter part
of the contract. Further reductions in per unit costs are expected throughout
fiscal 1999 as a result of the full implementation to the conductive buffer
product, higher throughput and other plant asset efficiencies. There can be no
assurance that these
18
efficiencies will be achieved. LED sales also increased by 70% in fiscal 1997
over 1996 amounts due to volume stemming from the original agreement and first
amendment with Siemens.
The Company continues to focus on obtaining additional LED customers
who are interested in ordering commercial quantities of the product. To meet
this goal the Company anticipates the release of new higher brightness blue and
green LED products, which are expected to be competitive in outdoor
applications, during the first half of fiscal 1999. Anticipated volume
associated with these new products, combined with lower LED pricing, are
expected to increase customer orders. If the Company is unable to expand its
customer base or release these new products, its revenue and earnings growth
potential could be adversely impacted. The Company believes that in order to
significantly grow market demand for LED products and to defray competition, it
must continue to substantially lower prices. During fiscal 1998, the Company's
average sales price per LED unit dropped 32% over 1997 levels. This decline in
price was more than offset by the 132% increase in product volume. The Company's
goal is to continue to lower sales prices to meet customer price points
throughout fiscal 1999. While the Company reported a lower average sales price
for LEDs during fiscal 1998, total product profitability increased due to higher
volumes and other efficiencies. Overall, average chip costs also declined in
fiscal 1998 due to a combination of a smaller chip size, the conversion to a two
inch diameter wafer, higher volume which spreads fixed costs over more units
and, in the latter half of the fourth quarter, benefits from the conductive
buffer technology.
During 1999, the Company anticipates further reductions in chip costs
due to the full year benefits of the conductive buffer process, higher volume
throughput and greater yield. If the Company is unable to realize these
benefits, profits are anticipated to deteriorate during fiscal 1999 due to
declining per unit sales prices in the Company's contract with Siemens. Greater
volume, while maintaining margins per unit, has been and will continue to be
Cree's strategy in the LED marketplace. Many current and potential customers
for the Company's products are based in Asia. Poor economic conditions and
currency devaluation in some countries may adversely affect the Company's
ability to increase sales volume both as a result of lower demand by customers
and competition reducing the price of products.
Wafer and other materials revenue has increased 56% in fiscal 1998 over
1997 due primarily to a 29% increase in wafer volume associated with a greater
interest in the worldwide research community for SiC-based products. The Company
continues to make improvements to the quality of its SiC material, thus
increasing the demand for research in microwave and power applications. These
wafer quality improvements have also led to corporate research funding,
including work performed toward the development of both microwave and power
devices during the year. Profits contributed by wafer sales are expected to rise
as the Company continues to improve quality while lowering costs due to higher
throughput and greater yield efficiency. During fiscal 1997, wafer sales grew
60% over 1996 amounts, due to the greater acceptance of the material in the
marketplace and a slight increase in the average sales price due to a greater
mix of premium wafer products available with low defect levels.
In July 1997, the Company announced development and supply agreements
with C3, to develop and supply bulk single crystal silicon carbide for gemstone
applications. The development program included the development of improved
processes for manufacturing colorless single crystalline SiC for use in
gemstones with diamond-like characteristics. This research is particularly
important as it also funds the development of larger diameter crystals. In
addition to the development agreement, the Company also entered into an
exclusive supply agreement where the output of dedicated production was supplied
and priced at cost plus a stipulated margin. For fiscal 1999, pricing under the
supply agreement has been superseded by a separate agreement that allows output
from dedicated production to be priced based on the quality of the material. In
addition, C3 has agreed to pay the Company up to $3.4 million for the purchase
of additional equipment to increase available capacity at Cree. Over one half of
this equipment was billed to C3 during fiscal 1998, however this transaction was
not recorded as revenue. Total revenue for materials used in gemstone
applications increased 89% in fiscal 1998 as compared to 1997 as a result of
these two agreements. Material purchased
19
by C3 under the supply agreement may be used solely for the fabrication and sale
of gemstones. During fiscal 1997 and 1996, the Company sold material products to
C3 at margins consistent with those achieved in connection with sales of similar
products to the Company's other customers.
Financial results for the display product line includes sales of both
modules and sign products. Revenue for the modules business increased by 29% in
fiscal 1998 over the prior year due to increased interest among customers for
the video display indoor stadium sign. Moving message sign sales by RCD, the
Company's subsidiary, suffered a 72% decline in revenue compared to 1997 due to
a 71% decrease in volume and slightly reduced average sales prices. This
reduction was prompted by the Company's shift to the module product line. During
fiscal 1998, the Company primarily sold an existing inventory of moving message
signs and did not expand or refresh the product line. The Company is currently
reviewing the business plan of these product lines to maximize sales for fiscal
1999. The Company expects the release of low priced, high brightness LED
products that will compete in outdoor applications in fiscal 1999. These new
LEDs are anticipated to change market opportunities for display products.
Revenue for the display business grew 76% in fiscal 1997 from 1996 due to the
introduction of the modules line of business during that year.
Contract Revenue
Research contract revenue increased 17% to $7,640,000 during fiscal
1998 as a result of the mix of funding from available contracts. Funding for
fiscal 1997 included a higher amount of proceeds recognized under two cost-share
arrangements. For these agreements, funds are recorded as a reduction in
research and development expense rather than as contract revenue. As funds
associated with these two programs were exhausted during the second quarter of
fiscal 1998, Company resources were shifted to programs under a cost-plus or
catalog price arrangement, in which funding is recorded as contract revenue.
Therefore, contract revenue was higher in fiscal 1998 than 1997. Contract
revenue grew 66% to $6,535,000 in fiscal 1997 as higher revenues were generated
as a result of more funding being made available from the U.S. government for
certain research contracts, primarily in the areas of microwave, power, blue
laser and basic material development.
License Fee Income
Included in revenue for fiscal 1997 is a one-time license fee of
$2,615,000. This license fee was earned pursuant to a License and Technology
Transfer Agreement entered into in September 1996 with Shin-Etsu Handotai Co.
Ltd. ("Shin-Etsu"). Pursuant to this agreement, the Company granted Shin-Etsu a
license to use certain epitaxial and device fabrication process technology for
the manufacture of the Company's LED product. The Company also recorded an
accrued expense of $186,000 payable in July 1998 to a third party that brokered
the agreement. Results for fiscal 1996 include 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 in October 1995 with Siemens, in which the
Company granted Siemens a license to use certain technology to manufacture blue
and green LED products. No license fee arrangements were recorded by the Company
during fiscal 1998.
Cost of Revenue
The Company's gross margin increased 47% to $14,552,000, or 34% of
revenue for fiscal 1998. The Company's gross margin as a percentage of sales was
34% and 24% in 1997 and 1996, respectively. License fee revenue, which has no
corresponding cost, is included in both 1997 and 1996 results. Without license
fees, gross margins would have been $7,263,000 or 28% of revenue for fiscal 1997
and $2,145,000 or 16% of revenue for the comparative period in 1996. The overall
increase in margin in 1998 stems from higher revenue and lower LED and materials
costs per unit. The lower unit costs were recognized due to higher
20
throughput, which more effectively utilized plant capacity, and yield
efficiencies on LED and wafer products. This greater throughput enabled the
Company to spread fixed cost investments over a larger volume of product.
Greater yield in LED applications resulted from a combination of a new smaller
die size, the new two inch diameter wafer and the introduction of the conductive
buffer technology. Yield was also higher for LED and materials due to plant
processing efficiency and improvements and a higher quality of wafer materials.
Higher margins in the future are largely contingent on the Company's ability to
increase the volume of LEDs produced, by gaining a larger customer base,
successfully introducing new products and continued savings from the conductive
buffer technology. These factors are significant due to the anticipated decline
in the average LED per unit sales price to be received in 1999. If the Company
is unable to improve efficiency under the new chip standards or gain orders for
additional volume, gross margin could be negatively impacted. Gross margin
improved in 1997 from 1996 levels, due to higher revenue and throughput
associated with the Siemens agreement, and yield efficiencies, which lowered the
manufacturing cost per unit.
The Company benefits from research and development efforts sponsored by
U.S. government contracts. Contracts are awarded to the Company to fund both
short-term and long-term research projects. For contracts under which the
Company anticipates that funding will exceed direct costs, all funding is
reported as contract revenue and direct costs are reported as cost of contract
revenue. For contracts under which the Company anticipates that direct costs
will exceed funding, costs are reflected as research and development expenses
with the related funding amounts offsetting these costs. Cost of contract
revenue has increased in fiscal 1998 over 1997 due primarily to the exhaustion
of funds available under two cost-share contracts during the first half of the
year. Costs for research under these two arrangements were included as research
and development expenses rather than a cost of contract revenue. When funding
under these two contracts was completed in the second quarter of fiscal 1998,
all resources were shifted to cost-plus and catalog priced contracts, where
expenses are recorded as a cost of contract revenue. Contract cost of revenue
was significantly higher in fiscal 1997 than 1996 as a result of more funding
being made available from the U.S. government for certain research contracts,
primarily in the areas of microwave, power, blue laser and basic material
development.
Research and development costs have decreased by 3% to $1,774,000 in
1998 due to a reduction in work performed under two cost-share contracts to
further the blue laser research. Net costs to the Company for these projects
were $276,000 and $671,000 for fiscal 1998 and 1997, respectively. These
cost-share contracts concluded during the first half of 1998. Additionally,
research and development costs for 1997, included a one-time write off of
$93,000 for the closure of the Company's Eastern European Division. The Eastern
European Division, located in St. Petersburg, Russia, was a research group
performing some of the Company's basic material and device development work.
Work performed under cost-share arrangements in fiscal 1997 also explains
why research and development costs were higher in that year than in 1996.
Sales and general and administrative expenses decreased 4% to
$4,131,100 for fiscal 1998, compared to 1997 levels as increased costs to
support the growth of the business were offset by two one-time insurance
payments to the Company. As a result of the dismissal in November 1997 of a
securities class action lawsuit filed in October 1996, the Company was
reimbursed $216,000 by its insurance carrier for costs incurred in defense of
the suit. In addition, as a result of a negotiated cost cap, the Company
received a $220,000 reimbursement of medical expenses that were incurred under a
partially self insured health plan. As a percentage of revenue, these costs have
decreased to 10% in 1998 from 15% and 19% in 1997 and 1996, respectively. Total
sales and general and administrative expenses increased 47% in fiscal 1997 over
1996 amounts due to higher costs associated with additional sales personnel to
focus the business on gaining new LED customers, the SEH license agreement
commission fee (a net present value of $172,000) and greater legal fees in
connection with the defense of a securities class action lawsuit that has since
been dismissed. The Company anticipates that sales and general and
administrative expenses will continue to rise in future
21
periods to support the anticipated growth of the business, however, the cost as
a percentage of total revenue is expected to decline as economies of scale
continue to be realized.
Other (income) expense includes a net loss recorded on the disposal of
certain fixed assets and the write-off of $66,000 for the remaining value of
goodwill associated with the acquisition of the Real Color Displays subsidiary.
In addition, the Company has entered into an agreement with C3 to sell equipment
manufactured by the Company at cost plus a reasonable overhead allocation. The
overhead allocation was recorded as "other operating income"; however, the
amount was more than offset by leasehold write-offs associated with the move to
the new facility and other asset disposals.
Net interest income increased by $123,000 in 1998 over 1997 results and
decreased by $260,000 when comparing 1997 to 1996, due to higher investable cash
balances available in fiscal 1998 and 1996. Cash balances were high in fiscal
1998 as the Company generated over $12 million from operations compared to $6
million in fiscal 1997. Also, the Company concluded a private equity placement
in September 1995 that also increased available cash in 1996.
The Company's income tax provision has increased to 29% for 1998 from a
5% effective rate experienced during 1997. The lower rate for 1997 resulted from
the utilization of net operating loss carryforwards. The Company anticipates a
slightly higher tax rate for fiscal 1999 as most carryforwards previously
available have now been utilized. The Company had no tax provision in 1996 as
the Company generated a net operating loss for tax purposes.
Liquidity and Capital Resources
Net cash provided by operations reached a record $12,092,000 in 1998
compared with $6,097,000 in 1997, and cash used in operations of $1,636,000 in
1995. These increases reported in 1998 and 1997 resulted from profitable
operations of the Company. If the Company achieves its goals of increasing
customer demand while lowering production costs, the Company expects that cash
provided by operations will increase in 1999 and will be sufficient to fund all
anticipated capital additions. The Company will; however, consider opportunities
to raise capital and to fund development costs through strategic alliances and
other manners.
The number of trade average days sales outstanding was reduced to 50
for 1998 from 57 and 96 days experienced in 1997 and 1996, respectively, due to
collections efforts during the year.
The Company invested $15,287,000 in capital equipment during 1998
compared to $8,115,000 and $14,740,000 spent during 1997 and 1996, respectively.
The majority of the 1998 spending, or $11,400,000, was due to the acquisition
and upfit of a new production facility near Research Triangle Park, North
Carolina. The total capital outlay for this facility and associated upfit is
estimated to be approximately $15,000,000 and is expected to be completed over
the next six months. The Company currently has a loan commitment of up to
$10,000,000 from a commercial bank to finance a portion of these expenditures.
As of June 28, 1998, approximately $8,667,000 had been drawn against this loan.
At this time, the Company anticipates capital additions in 1999 to be 25% lower
than amounts spent in 1998 and intends to fund these additions with cash
provided by operations and cash on hand. In addition, the Company also expects
to draw the remaining $1,333,000 on the loan commitment and may consider other
financing alternatives. During 1997, investments were made for equipment
additions in the crystal growth and epitaxial departments. During 1996, a
significant investment was made for equipment related to the production of LED
and wafer products. Financing activities provided the Company $10,341,000 during
1998 mostly due to the proceeds from the issuance of long term debt discussed
above. In addition, financing activities yielded $20,924,000 during fiscal 1996.
The majority of the funding was provided by the September 1995 private placement
which netted approximately $17.5 million.
22
Year 2000
The Company's products are of a nature that they are not subject to
failure because of Year 2000 issues. The Company however, has assigned full-time
information technology professionals to the task of identifying and resolving
Year 2000 problems that may affect the Company's business, and has adopted a
phased Year 2000 compliance plan. During the first phase, commenced in April
1998 and targeted for completion in December 1998, the Company will inventory
and collect documentation on all of its computers, computer related equipment,
and equipment with embedded processors. In addition, the Company will contact
critical vendors and suppliers to obtain assurances of their ability to ensure
smooth delivery of products and services after December 1999. In the second and
third phases, the Company will prioritize and implement necessary repairs or
replacements to equipment in order to achieve Year 2000 compliance, which it
expects to complete in the first quarter of 1999. The final phase will consist
of a testing program, scheduled for completion in the second quarter of 1999.
The Company has not prepared estimates of costs for correction of Year 2000
problems. Based on information available at this time, including the Year 2000
compliance status of equipment that has been examined as well as the anticipated
replacement schedule for equipment, the Company does not believe that the cost
of remedial actions will have a material adverse effect on the Company's results
of operations or financial condition. There can be no assurance, however, that
there will not be a delay in, or increased costs associated with, the
implementation of corrections as the Year 2000 compliance plan is performed.
Failure to implement such changes could have an adverse effect on future results
of operations. In addition, unexpected costs of correcting equipment that has
not yet been fully evaluated could have an adverse effect on future results of
operations.
23
Item 8. Financial Statements and Supplementary Data
Index to Consolidated Financial Statements
Page
----
Report of Independent Accountants 25
Consolidated Balance Sheets as of June 28, 1998 and
June 30, 1997 26
Consolidated Statements of Operations for the years ended
June 28, 1998, and June 30, 1997 and 1996 27
Consolidated Statements of Cash Flows for the years ended
June 28, 1998, and June 30, 1997 and 1996 28
Consolidated Statements of Shareholders' Equity for the years
ended June 28, 1998, and June 30, 1997 and 1996 30
Notes to Consolidated Financial Statements 31
24
REPORT OF INDEPENDENT ACCOUNTANTS
July 22, 1998
Board of Directors and Shareholders
Cree Research, Inc.
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, cash flows and shareholders' equity,
present fairly, in all material respects, the financial position of Cree
Research, Inc. and subsidiaries at June 28, 1998 and June 30, 1997, and the
results of their operations and their cash flows for the year ended June 28,
1998 and for the two years in the period ended June 30, 1997, in conformity with
generally accepted accounting principles. These financial statements are the
responsibility of the Company's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with generally accepted auditing
standards which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
Raleigh, North Carolina
25
CREE RESEARCH, INC.
CONSOLIDATED BALANCE SHEETS
(in 000's, except per share amounts)
June 28, June 30,
1998 1997
-------- --------
ASSETS
Current assets:
Cash and cash equivalents $ 17,680 $ 10,448
Marketable securities 657 --
Accounts receivable, net 10,479 7,694
Inventories 2,543 3,949
Deferred income tax 1,952 1,830
Prepaid expenses and other current assets 1,347 466
-------- --------
Total current assets 34,658 24,387
Property and equipment, net 36,476 24,333
Patent and license rights, net 1,525 1,267
Other assets 65 150
-------- --------
Total assets $ 72,724 $ 50,137
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable, trade $ 5,595 $ 2,248
Current maturities of long term debt 17 --
Accrued salaries and wages 391 292
Other accrued expenses 1,052 834
-------- --------
Total current liabilities 7,055 3,374
Long term liabilities:
Long term debt 8,650 --
Deferred income tax 2,154 1,638
-------- --------
Total long term liabilities 10,804 1,638
Shareholders' equity:
Preferred stock, par value $0.01; 2,750 shares authorized;
none issued and outstanding -- --
Common stock, $0.005 par value; 14,500 shares authorized;
shares issued and outstanding 12,989 at June 28, 1998
and 12,523 at June 30, 1997 65 62
Additional paid-in-capital 49,676 46,214
Retained earnings (deficit) 5,124 (1,151)
-------- --------
Total shareholders' equity 54,865 45,125
-------- --------
Total liabilities and shareholders' equity $ 72,724 $ 50,137
======== ========
The accompanying notes are an integral part of the consolidated financial
statements.
26
CREE RESEARCH, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in 000's except per share amounts)
June 28, June 30, June 30,
1998 1997 1996
-------- -------- --------
Revenue:
Product revenue, net $ 34,891 $ 19,823 $ 9,689
Contract revenue, net 7,640 6,535 3,945
License fee income -- 2,615 1,423
-------- -------- --------
Total revenue 42,531 28,973 15,057
Cost of revenue:
Product revenue, net 21,727 13,388 8,411
Contract revenue, net 6,252 5,707 3,078
-------- -------- --------
Total cost of revenue 27,979 19,095 11,489
Gross margin 14,552 9,878 3,568
Operating expenses:
Research and development 1,774 1,826 1,286
Sales, general and administrative 4,131 4,301 2,917
Other (income) expense 502 639 (11)
-------- -------- --------
Income (loss) from operations 8,145 3,112 (624)
Interest income, net 730 607 867
-------- -------- --------
Income before income taxes 8,875 3,719 243
Income tax expense 2,600 177 --
-------- -------- --------
Net income $ 6,275 $ 3,542 $ 243
======== ======== ========
Basic earnings per common share $ 0.49 $ 0.28 $ 0.02
======== ======== ========
Diluted earnings per common share $ 0.47 $ 0.27 $ 0.02
======== ======== ========
Weighted Average Shares Outstanding 13,493 13,126 12,615
======== ======== ========
The accompanying notes are an integral part of the consolidated financial
statements.
27
CREE RESEARCH, INC.
CONSOLIDATED STATEMENTS OF CASH FLOW
(in 000's)
June 28, June 30, June 30,
1998 1997 1996
-------- -------- --------
Operating activities:
Net income $ 6,275 $ 3,542 $ 243
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 4,217 3,356 1,765
Loss (gain) on disposal of property & equipment 719 631 (8)
Loss on write off of patents 17 141 --
Amortization of patent rights 102 108 126
Amortization & write off of goodwill 86 41 41
Purchase of marketable trading securities (1,500) -- --
Proceeds from sale of marketable trading securities 421 -- --
Loss on marketable trading securities 32 -- --
Deferred income taxes 394 (192) --
Tax benefits associated with stock options 1,791 96 --
Changes in assets & liabilities:
Accounts receivable (2,398) (891) (3,258)
Inventories 1,406 (723) (1,549)
Deferred cost on research contracts -- -- 81
Prepaid expenses & other assets (882) (262) 49
Accounts payable, trade 1,092 (226) 714
Accrued expenses 320 476 160
-------- -------- --------
Net cash provided by (used in) operating activities 12,092 6,097 (1,636)
-------- -------- --------
Investing activities:
Maturity of investment securities -- 1,787 2,124
Purchase of property & equipment (15,287) (8,115) (14,740)
Proceeds from sale of assets 463 13 52
Purchase of patent rights (377) (310) (310)
-------- -------- --------
Net cash used in investing activities (15,201) (6,625) (12,874)
-------- -------- --------
Financing activities:
Proceeds from issuance of long-term debt 8,667 -- --
Net proceeds from issuance of common stock 2,936 926 20,924
Repurchase of common stock (1,262) (112) --
-------- -------- --------
Net cash provided by financing activities 10,341 814 20,924
-------- -------- --------
Net increase in cash and cash equivalents $ 7,232 $ 286 $ 6,414
Cash and cash equivalents:
Beginning of year 10,448 10,162 3,748
-------- -------- --------
End of year $ 17,680 $ 10,448 $ 10,162
======== ======== ========
The accompanying notes are an integral part of the consolidated financial
statements.
28
CREE RESEARCH, INC.
CONSOLIDATED STATEMENTS OF CASH FLOW
(in 000's)
(Continued)
Years Ended
-------------------------------------
June 28, June 30, June 30,
1998 1997 1996
-------------------------------------
Supplemental disclosure of cash flow information:
Cash paid for interest, net of amounts capitalized $ 74 $ - $ 5
=====================================
Cash paid for income taxes $ 336 $ 300 $ -
=====================================
The accompanying notes are an integral part of the consolidated financial
statements.
29
CREE RESEARCH, INC.
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
YEARS ENDING JUNE 28, 1998 AND JUNE 30, 1997 AND 1996
(IN 000'S)
Common Additional Total
Stock Paid-in Retained Unearned Treasury Shareholders'
Par Value Capital Earnings Compensation Stock Equity
--------- ------- -------- ------------ -------- -------------
Balance at June 30, 1995 $ 52 $ 24,427 $ (4,936) $ (2) $ (38) $ 19,503
Common stock options exercised
for cash, 122 shares 1 412 413
Common stock warrants exercised
for cash, 665 shares 3 2,916 2,919
Compensation expense for
common stock options 2 2
Proceeds from sale of 1,079
shares of common stock and
300 common stock warrants,
net of issuance costs of $625 5 17,587 17,592
Net income 243 243
-------- -------- -------- -------- -------- --------
Balance at June 30, 1996 61 45,342 (4,693) -- (38) 40,672
Common stock options exercised
for cash, 52 shares 160 160
Common stock warrants exercised
for cash, 203 shares 1 766 767
Purchase of common stock for the
treasury, 10 shares (112) (112)
Retirement of 20 treasury shares (150) 150 --
Income tax benefits from stock
option exercises 96 96
Net income 3,542 3,542
-------- -------- -------- -------- -------- --------
Balance at June 30, 1997 62 46,214 (1,151) -- -- 45,125
Common stock options exercised
for cash, 217 shares 1 1,693 1,694
Common stock warrants exercised
for cash, 331 shares 2 1,240 1,242
Purchase of common stock for the
treasury, 82 shares (1,262) (1,262)
Retirement of 82 treasury shares (1,262) 1,262 --
Income tax benefits from stock
option exercises 1,791 1,791
Net income 6,275 6,275
-------- -------- -------- -------- -------- --------
Balance at June 28, 1998 $ 65 $ 49,676 $ 5,124 $ -- $ -- $ 54,865
======== ======== ======== ======== ======== ========
The accompanying notes are an integral part of the consolidated financial
statements.
30
CREE RESEARCH, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. NATURE OF BUSINESS
Cree Research, Inc. ("the Company" or "Cree"), a North Carolina
corporation, develops, manufactures, and markets silicon carbide-based
semiconductor devices. Revenues are primarily derived from the sale of blue
light emitting diodes ("LEDs"), silicon carbide ("SiC") based materials and
full-color LED based electronic displays and modules. The Company markets its
blue LED chip products principally to customers who incorporate them into
packaged lamps for resale to original equipment manufacturers. The Company also
sells SiC material products to corporate, government, and university research
laboratories. In addition, the Company is engaged in a variety of research
programs related to the advancement of SiC process technology and the
development of electronic devices that take advantage of SiC's unique physical
and electronic properties. These research projects are primarily funded by
Federal government agencies and departments. The Company recovers the costs of a
majority of its research and development efforts from revenues on these
contracts with agencies of the Federal government.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The consolidated financial statements include the accounts of Cree
Research, Inc., and its wholly-owned subsidiaries, Real Color Displays,
Inc. ("RCD"), Cree Research FSC, Inc. and Cree Technologies, Inc. All
material intercompany accounts and transactions have been eliminated in
consolidation.
Change in Fiscal Year
On September 24, 1997, the Board of Directors of Cree Research, Inc.
changed the Company's fiscal year from the twelve months ending June 30, to a 52
or 53 week year ending on the last Sunday in the month of June. Accordingly, all
quarterly reporting reflected a 13 week period in fiscal 1998, except that the
period ended September 28, 1997, which commenced July 1, 1997, reflected the
results of twelve weeks and five days. The Company's 1998 fiscal year extended
for the period from July 1, 1997 to June 28, 1998.
Estimates
The preparation of these financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities, and
the disclosure of contingent assets and liabilities, at June 28, 1998 and June
30, 1997, and the reported amounts of revenues and expenses during the years
ended June 28, 1998 and June 30, 1997 and 1996. Actual amounts could differ from
those estimates.
Revenue Recognition
The Company recognizes product revenue at the time of shipment or 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. License fee income is recognized when the transfer of
licensed technology is completed.
31
Contract revenue represents reimbursement by various U.S. Government
entities to aid in the furthering of the development of the Company's technology
by supplementing the Company's research and development efforts. Any resulting
technology obtained by the Company through these efforts remain the property of
the Company after the completion of the contract, subject to certain license
rights obtained by the government. 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.
In September 1996, the Company entered into a license and supply
agreement with Shin-Etsu Handotai Co. LTD. ("Shin-Etsu") and other parties to
use certain LED fabrication technology 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 royalties based on a percentage of
sales of products made using the licensed technology. The license fee was
payable in installments which totaled $2,700,000. As of June 28, 1998, all
license fees have been received. The Company also has recorded a short-term
accrued expense of $186,000 payable in the first quarter of fiscal 1999 to the
third party that brokered the license agreement. Substantially all of the
Company's obligations to transfer the licensed technology were performed during
fiscal 1997, and the net present value of the license fee payments and
commission were recognized. In October 1995, the Company also entered into an
agreement to license its technology for the joint development and manufacture of
LEDs using Cree's technology to Siemens A.G. License fees are payable in
installments totaling $1,500,000. As of June 28, 1998, all fees have been
received. The Company's obligation to transfer the licensed technology was
substantially completed during fiscal 1996, and the net present value of the
license fee payments was recorded as revenue at that time.
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.
Marketable Securities
Investments are accounted for in accordance with Statement of Financial
Accounting Standards No. 115 (SFAS No. 115) "Accounting for Certain Investments
in Debt and Equity Securities". This statement requires certain securities to be
classified into three categories:
(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 or
losses excluded from earnings and reported as a separate component
of stockholders' equity.
32
The Company's short-term investments are comprised of equity securities
that are classified as trading securities, which are carried at their fair value
based upon quoted market prices of those investments at June 28, 1998, with net
realized and unrealized gains and losses included in net earnings.
As of June 28, 1998, short-term investments consist of common stock
holdings in C3, Inc. ("C3"), a portion of which were purchased in November 1997.
The Company's president has, through a binding agreement, promised to indemnify
the Company for losses of up to $300,000, plus the lesser of $100,000 or the net
difference between the per share selling price and $9.375 per share for all
shares of C3 common stock sold by Cree. This indemnity covers losses that may
result from the sale of shares purchased in November 1997 below the purchase
price paid, offset by gains realized on shares acquired directly from C3 in
January 1997 (see below). Payment of this obligation is due within ten days
after receipt by the president of the Company's written demand made pursuant
to a vote of the majority of the members of the Board of Directors. At June 28,
1998, the Company had recorded a $390,000 receivable from the president
(included in net accounts receivable) based upon this agreement for the net
realized and unrealized losses on this investment. Realized losses on shares of
C3 stock sold by the Company during fiscal 1998 totaled $254,000, and unrealized
losses offset by the unrealized gain on shares acquired from C3 directly (see
below) were $168,000 at June 28, 1998. Approximately $32,000 of losses on the
investment in C3 stock is included in other income (expense) for fiscal 1998.
In addition to the shares of C3 purchased in November 1997, the Company
acquired 24,601 shares of C3 common stock in January 1997. These shares were
issued pursuant to an option C3 granted to the Company in 1995. The option gave
the Company the right to acquire, for an aggregate consideration of $500, one
percent of the outstanding common stock of C3. C3 retained the right to waive
the consideration and issue the stock at any time, which it elected to do in
January 1997. The shares issued pursuant to the option are restricted securities
within the meaning of Rule 144 under the Securities Act of 1933, which permits
the sale of such securities without registration if certain conditions are met.
The shares first became eligible for sale under Rule 144 in the third quarter of
fiscal 1998.
Inventories
Inventories are stated at the lower of cost or market, with cost being
determined under the first-in, first-out (FIFO) method. Inventories consists of
the following:
June 28, June 30,
1998 1997
--------------- ------------
Raw materials $ 999,000 $ 1,559,000
Work-in-progress 752,000 1,374,000
Finished goods 792,000 1,016,000
--------------- ------------
$ 2,543,000 $ 3,949,000
=============== ============
Property and Equipment
Property and equipment are recorded at cost and depreciated on a
straight-line basis over the estimated useful lives of the assets, which range
from three to 20 years. Leasehold improvements are amortized over the life
of the related lease. Expenditures for repairs and maintenance are charged to
expense as incurred. The costs of major renewals and betterments are capitalized
and depreciated over their estimated useful lives. The cost and related
accumulated depreciation of the assets are removed from the accounts upon
disposition and any resulting gain or loss is reflected in operations.
33
During the first quarter of fiscal 1996, the Company changed its
previous estimate on the useful lives of some of its manufacturing equipment
from five to nine years. The change in estimate was based on the Company's
experience with similar fixed assets. The net adjustment increased net income
approximately $280,000, or $0.02 per share, for fiscal 1996.
The Company has entered into an agreement with C3 to sell crystal
growth equipment manufactured by the Company to C3 at cost plus a reasonable
overhead allocation. As a result of this transaction, the Company has recognized
the overhead allocation as "other operating income".
In November 1997, the Company purchased real property consisting of
approximately 30 acres of land with a production facility of approximately
162,000 square feet and a total of approximately 35,000 square feet of service
and warehouse buildings. This property is located in Durham, North Carolina, in
the vicinity of the Research Triangle Park. The purchase price of the land and
buildings was $3,000,000. The Company moved most of its sales and administrative
personnel to this facility in January 1998. The Company anticipates it will
relocate several other operations to this facility over the next few quarters.
All areas, with the exception of certain crystal growth and wafer fabrication
assets, are expected to relocate during fiscal 1999.
The Company assesses the realizability of the carrying value of its
investment in property and equipment whenever events or changes in circumstance
indicate that an impairment may have occurred in accordance with the provisions
of Statement of Financial Accounting Standards No. 121 ("SFAS No. 121"),
"Accounting for Impairment of Long Lived Assets and Assets to be Disposed of".
As of June 28, 1998, the Company has not recorded any impairment in the carrying
value of its property and equipment.
Patent and License Rights
Patent rights reflect costs incurred to enhance and maintain the
Company's intellectual property position. License rights reflect costs incurred
to use the intellectual property of others. Both are amortized on a straight
line basis. During fiscal 1997, the Company changed its previous estimate of the
useful lives of patents from 17 years beginning at the date of patent issue to
20 years from the date of patent application to conform to a legislative
amendment made to the U.S. patent laws which became effective in June 1995. This
change in estimate had no material impact to net income or earnings per share,
since the average period of time between patent application and issue is
generally about three years. Amortization expense was $102,000, $108,000 and
$126,000, for the years ended June 28, 1998 and June 30, 1997 and 1996,
respectively. Total accumulated amortization for patents was approximately
$560,000 and $460,000 at June 28, 1998 and June 30, 1997, respectively.
Goodwill
Goodwill represented the amount by which the costs to acquire the net
assets of the Real Color Displays subsidiary exceeded their related fair value
at acquisition. Based on a review of undiscounted cash flows of the subsidiary
anticipated over the remaining amortization period, the Company determined that
goodwill had been impaired. As a result, the Company wrote off the remaining
$66,000 carrying value of such goodwill in the second quarter of fiscal 1998. As
required by generally accepted accounting principles, this charge was included
in the results of operations.
Research and Development 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
34
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 a cost of capital
expense. 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 funded to the Company. Activities performed
under both of these arrangements include research regarding silicon carbide and
gallium nitride materials. The contracts typically require the submission of a
written report that documents the results of such research.
Funding on contracts under which the Company anticipates that funding
will exceed direct costs over the life of the contract is recorded as contract
revenue and related costs are reported as a cost 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, direct costs are shown 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 reflected in the statements of
operations:
Year ended (in 000's)
June 28, June 30, June 30,
1998 1997 1996
-------- -------- --------
Net research and development costs $ 276 $ 671 $ 368
Government funding 601 2,186 1,918
------ ------ ------
Total direct costs incurred $ 877 $2,857 $2,286
====== ====== ======
As of June 28, 1998, all funding under contracts where the Company
anticipates that direct costs will exceed amounts to be funded has been
exhausted. Therefore, the Company anticipates that all future funding under
existing contracts will be reflected as contract revenue while direct costs will
be reported as contract cost of revenue.
Interest Capitalization
During the year ended June 28, 1998, the Company capitalized interest
on funds used to construct property, plant and equipment in connection with the
newly acquired facility. Interest capitalized during fiscal 1998 was $128,000.
Credit Risk, Major Customers and Major Suppliers
Financial instruments which potentially subject the Company to a
concentration of credit risk consist principally of cash equivalents and
accounts receivable. The Company's cash equivalents consist of U.S. Treasury
bills, government agency bonds and commercial paper. Certain bank deposits may
at times be in excess of the FDIC insurance limit.
The Company sells its products to manufacturers and researchers
worldwide and generally requires no collateral. The Company maintains reserves
for potential credit losses, and such losses, in the aggregate, have generally
been within management's expectations. The Company presently derives primarily
all of its contract revenues from contracts with the U.S. Department of Defense.
Approximately 18% and 33%, respectively, of the Company's accounts receivable
balance at June 28, 1998 and June 30, 1997 was due from the Department of
Defense. In addition, the Company had amounts due from Siemens totaling 37% and
35
19%, of accounts receivable balances at June 28, 1998 and June 30, 1997,
respectively, and amounts due from C3 totaling 23% and 1%, of accounts
receivable balances at June 28, 1998 and June 30, 1997, respectively.
The Company has derived its product revenue from sales primarily in the
United States, the Far East, and Europe as follows:
Year Ended
1998 1997 1996
---- ---- ----
United States ................... 26% 21% 31%
Far East ........................ 15% 33% 27%
Europe .......................... 58% 44% 38%
Other ........................... 1% 2% 4%
One customer accounted for 51% and 46% of product revenue for fiscal
1998 and 1997, respectively. Another customer accounted for 13% and 2% of
product revenue for fiscal 1998 and 1997, respectively. In addition, two
customers accounted for 32% of product revenue in fiscal 1996. The Department of
Defense accounted for 93%, 99% and 97% of contract revenues during fiscal 1998,
1997, and 1996, respectively.
The Company depends on single or limited source suppliers for a number
of raw materials and components used in its SiC wafer products and LEDs. Any
interruption in the supply of these key materials or components could have a
significant adverse effect on the Company's operations.
Per Share Data
Basic earnings per common share is computed using the weighted average
number of shares outstanding. Diluted earnings per common share is computed
using the weighted average number of shares outstanding adjusted for the
incremental shares attributed to outstanding options to purchase common stock.
Incremental shares of 631,000, 670,000 and 789,000 in 1998, 1997 and
1996, respectively, were used in the calculation of diluted earnings per common
share.
Accounting for Stock Based Compensation
In accordance with Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees, no compensation is recorded for stock
options or other stock-based awards that are granted to employees with an
exercise price equal to or above the common stock price on the grant date.
Compensation related to performance share grants is recognized from the grant
date until the performance conditions are satisfied, based on the market price
of the Company's common stock.
In October, 1995, the Financial Accounting Standards Board ("FASB")
issued Statement No. 123 ("FAS 123"), "Accounting for Stock Based Compensation."
This Statement establishes fair value as the measurement basis for equity
instruments issued in exchange for goods or services and stock-based
compensation plans. Fair value may be measured using quoted market prices,
option-pricing models or other reasonable estimation methods. FAS 123 permits
the Company to choose between adoption of the fair value based method or
disclosing pro forma net income information. The Statement is effective for
transactions entered into after December 31, 1995. The Company will continue to
account for stock-based compensation in accordance with Accounting Principles
Board Opinion No. 25, as amended, and provide only the pro forma disclosures
required by FAS 123.
3. ACCOUNTS RECEIVABLE
36
The following is a summary of accounts receivable:
June 28, 1998 June 30, 1997
------------- -------------
Trade receivables $ 8,971,000 $ 5,210,000
Other short term receivables 1,659,000 2,700,000
----------- -----------
10,630,000 7,910,000
Allowance for doubtful accounts 151,000 216,000
----------- -----------
Current receivables 10,479,000 7,694,000
Long term receivables 56,000 54,000
----------- -----------
Total accounts receivable $10,535,000 $ 7,748,000
=========== ===========
The following table summarizes the changes in the Company's allowance for
doubtful accounts for the years ended June 28, 1998, June 30, 1997 and 1996:
Allowance for Doubtful Accounts:
(dollars in thousands)
Balance At Charges To Deductions Balance At
Years Beginning Cost and (Write-offs End of
Ended of Period Expenses Charged To Reserve) Period
- ----- --------- -------- ------------------- ------
1998 $ 216 50 (115) $ 151
1997 $ 50 190 (24) $ 216
1996 $ 22 203 (175) $ 50
4. PROPERTY AND EQUIPMENT
The following is a summary of property and equipment:
June 28, 1998 June 30, 1997
------------ -------------
Office equipment and furnishings....... $1,372,000 $909,000
Land and buildings .................... 3,501,000 -
Machinery and equipment................ 28,136,000 22,312,000
Construction in progress............... 9,074,000 2,669,000
Leasehold improvements................. 4,697,000 5,420,000
------------ -------------
46,780,000 31,310,000
Accumulated depreciation and
amortization......................... (10,304,000) (6,977,000)
------------ -------------
$36,476,000 $24,333,000
============ =============
Depreciation and amortization of property and equipment totaled
$4,217,000, $3,356,000 and $1,765,000 for the year ended June 28, 1998, June 30,
1997 and June 30, 1996, respectively.
37
5. SHAREHOLDERS' EQUITY
The Board of Directors is authorized to issue 1,250,000 and 1,500,000
shares of Class A Voting and Class B Non-Voting preferred stock, respectively,
each with a par value of $0.01 per share, at its discretion. This preferred
stock may be issued in one or more series with the number of shares,
designation, relative rights, preferences, and limitations to be determined by
resolution of the Board of Directors.
6. STOCK OPTIONS AND STOCK WARRANTS
As permitted by FAS 123, "Accounting For Stock-Based Compensation", the
Company has elected to follow Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" and related interpretations and
amendments in accounting for its employee stock option plans.
The Company's Amended and Restated Equity Compensation Plan has
authorized the grant of options for up to 2,540,000 shares of the Company's
common stock. All options granted have 10 year terms and vest and become fully
exercisable within 5 years. The Company had granted 96,000 options with a 10
year term for shares of the Company's common stock under the Stock Option Plan
for Non-Employee Directors (Directors Formula Plan). This Plan was terminated in
November 1997 and all 96,000 options granted under this plan are now fully
vested. The Company's current stock plans provide for grants of options with
exercise prices equal to or exceeding fair market value on the date of grant.
Pro forma information regarding net income and earnings per share is
required by Statement 123, and has been determined as if the Company had
accounted for its employee stock options under the fair value method of the
Statement. The fair value of these options was estimated at the date of grant
using a Black-Scholes option pricing model with weighted average risk free rates
of interest of 5.6% and 6.7%, for the years ended June 28, 1998 and June 30,
1997, respectively. The volatility factor of the expected market price of the
Company's common stock is .748 and the weighted-average expected life of the
options was 7 years for executives and directors and 5 years for other
employees.
For purposes of pro-forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. The Company's
pro forma information is as follows:
YEARS ENDED
-----------------------------------------
JUNE 28, JUNE 30, JUNE 30,
1998 1997 1996
---------- ---------- ---------
Net income, as reported $ 6,275,000 $ 3,542,000 $243,000
Pro forma net income, as adjusted
for FAS 123 4,405,000 1,418,000 243,000
Pro forma earnings per share:
Basic $ 0.34 $ 0.11 $ 0.02
If Diluted $ 0.33 $ 0.11 $ 0.02
38
The following table details the number of stock options outstanding and their
related exercise prices as of June 28:
Number of Options Outstanding As Of June 28, 1998
-------------------------------------------------
Exercise Number of Weighted-Average
Price Options Contractual Life
-------- --------- ---------------
$ 0.42 5,497 2 years
$ 3.13 8,000 6 years
$ 3.63 250,200 5 years
$ 3.75 13,317 3 years
$ 4.00 78,700 6 years
$ 4.38 6,000 6 years
$ 6.82 6,700 5 years
$ 7.38 6,000 6 years
$ 9.38 26,600 9 years
$ 10.25 14,500 9 years
$ 11.19 16,800 8 years
$ 12.98 409,100 9 years
$ 14.38 203,400 7 years
$ 15.75 48,000 8 years
$ 16.38 43,500 10 years
$ 17.75 19,000 10 years
$ 18.75 40,000 9 years
$ 19.38 10,000 10 years
---------
1,205,314
=========
39
Total Option Activity
-------------------------------------------------------------------
June 28, 1998 June 30, 1997 June 30, 1996
Weighted Weighted Weighted
Options Average Options Average Options Average
(in 000's) Price (in 000's) Price (in 000's) Price
-------- ------- ------------------ --------------------
Outstanding-beginning of year 927 $ 4.76 632 $ 4.39 769 $ 4.23
Granted 542 $13.98 381 $ 13.56 - $ -
Exercised 217 $ 7.80 52 $ 3.08 122 $ 3.39
Forfeited 47 $ 8.67 34 $ 8.05 15 $ 4.36
-------- ------ -------
Outstanding-end of year 1205 $10.19 927 $ 4.76 632 $ 4.39
Exercisable at end of year 599 $ 8.40 702 $ 7.44 439 $ 3.78
During fiscal year 1992, the Company issued stock warrants to
purchasers of Class B Non-Voting preferred stock, Series C. The warrants
entitled the holders to purchase 607,320 shares of common stock at $3.75 per
share. In September 1992, the Company issued stock warrants to additional
purchasers of Class B Non-Voting preferred stock, Series C. The warrants
entitled the holders to purchase 363,644 shares of common stock at $4.13 per
share. Warrants to purchase 331,326, 202,996 and 425,642 shares of common stock
were exercised during the years ended June 28, 1998, June 30, 1997 and 1996,
respectively. All remaining warrants expired effective February 8, 1998.
In connection with the Company's September 1995 private placement, the
Company issued an additional 300,000 warrants, which have an exercise price of
$27.23 and expire September 2000. As of June 28, 1998, all of these warrants
remain outstanding and represent the only warrants outstanding.
7. COMMITMENTS
The Company currently leases three facilities under four separate lease
agreements. These facilities are comprised of both office and manufacturing
space. The first facility has a remaining lease period of approximately three
and one half years for a multi-suite block. Effective May 1, 1998, the Company
has notified the lessor of its intention to exercise a right to terminate for
all suites with the exception of the base suite. This right to terminate will be
effective May 1, 1999. Also associated with this facility is a sublease
agreement entered into in fiscal 1996 to lease an adjacent 1,900 square feet.
That sublease expires in October 1998 and will not be renewed. The lease term
for the second facility began in September 1995. This facility has a remaining
lease period of approximately two years with two options to renew for a total of
four additional years. All of these agreements provide for rental adjustments
for increases in property taxes, the consumer price index and general property
maintenance.
Rent expense associated with these leases totaled $522,000, $549,000
and $388,000 for the years ended June 28, 1998, and June 30, 1997 and 1996,
respectively. Future minimum rentals as of June 28, 1998 under these leases are
as follows:
40
Minimal Rental
Year Ended Amount
---------- -----------
1999 $ 389,000
2000 334,000
2001 284,000
2002 138,000
Total $ 1,145,000
8. LONG-TERM DEBT
In November 1997, the Company entered into a term loan from a
commercial bank for up to $10,000,000 to finance the purchase and upfit of the
new main facility in Durham, North Carolina. Approximately $2,950,000 was
disbursed under the loan to finance the initial purchase of the facility with
the remaining proceeds expected to be disbursed on a monthly basis based on
actual expenditures incurred. Draws under the loan agreement may be made during
the eighteen month period ending in May 1999. The loan, which is collateralized
by the purchased property and subsequent upfits, accrues interest at a fixed
rate of 8% and carries customary covenants, including the maintenance of a
minimum tangible net worth and other requirements. Accrued interest is due
monthly through May 1999, at which time the outstanding principal balance will
be amortized over twenty years until 2011, when the loan balance becomes due. At
June 28, 1998, short term and long term borrowings associated with this loan
were $17,000 and $8,650,000, respectively, leaving $1,333,000 unused and
available.
The aggregate maturities for long-term debt for the five years after
June 28, 1998 are :
Amount
Year Ended Due
---------- ------------
1999 $ 17,000
2000 213,000
2001 230,000
2002 250,000
2003 270,000
Thereafter 7,687,000
------------
Total $ 8,667,000
============
9. INCOME TAXES
The Company accounts for its income taxes under the provisions of
Statement of Financial Accounting Standards No. 109 ("FAS 109"), "Accounting for
Income Taxes." Under the asset and liability method of FAS 109, deferred tax
assets and liabilities are recognized for the estimated future tax consequences
attributable to differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax bases. Deferred tax
assets and liabilities are measured using enacted tax rates in effect for the
year in which those temporary differences are expected to be recovered or
settled. Under FAS 109, the effect on deferred tax assets and liabilities of a
change in tax rates is recognized in income in the period that includes the
enactment date.
41
The actual income tax expense attributable to earnings for the years
ended June 28, 1998, and June 30, 1997 and 1996 differed from the amounts
computed by applying the U.S. federal tax rate of 34 percent to pretax earnings
as a result of the following:
1998 1997 1996
------------- ----------- ----------
Federal income tax provision at statutory
rate (34%) $ 3,018,000 $ 1,265,000 $ 83,000
State tax provision 166,000 193,000 36,000
Increase (decrease) in income tax expense
resulting from:
Foreign sales corporation (214,000) - -
Increase (decrease) in valuation allowance (358,000) (1,279,000) (106,000)
Other (12,000) (2,000) (13,000)
------------- ----------- ----------
Income tax expense $ 2,600,000 $ 177,000 $ -
============= =========== ==========
The following are the components of the provision for income taxes for the years
ended June 28, 1998 and June 30, 1997:
1998 1997
---------- ---------
Current:
Federal $ 699,000 $ 54,000
Foreign Tax Withholding 50,000 220,000
State 269,000 95,000
---------- ---------
1,018,000 369,000
Deferred:
Federal 1,582,000 (442,000)
State - 250,000
---------- ---------
1,582,000 (192,000)
---------- ---------
Net Provision $ 2,600,000 $177,000
========== =========
There is no tax provision for fiscal 1996.
The tax effects of temporary differences that give rise to significant portions
of the deferred tax assets and deferred tax liabilities are as follows:
42
June 28, June 30,
1998 1997
---------- ----------
Deferred tax assets:
Net operating loss carryforwards $ 1,304,000 $ 2,413,000
Research tax credits 169,000 157,000
Compensation 62,000 115,000
Inventory 120,000 199,000
Bad debt 56,000 84,000
Goodwill -- 31,000
Alternative minimum tax 261,000 64,000
Foreign tax credit 270,000 220,000
Other -- 10,000
----------- -----------
Total gross deferred tax assets 2,242,000 3,293,000
Less valuation allowance (290,000) (1,463,000)
----------- -----------
Net deferred tax asset 1,952,000 1,830,000
Deferred tax liabilities:
Property and equipment, due
to depreciation 2,154,000 1,638,000
----------- -----------
Gross deferred tax liabilities 2,154,000 1,638,000
----------- -----------
Net deferred tax asset (liability) $ (202,000) $ 192,000
=========== ===========
The net change in the total valuation allowance for the years ended
June 28, 1998 and June 30, 1997 was $1,173,000 and $1,201,000, respectively.
Included in the valuation allowance is $0 and $815,000, respectively, for 1998
and 1997 to offset net operating losses ("NOL") generated by the exercise of
stock options. The reduction in the valuation allowance does not impact the 1998
tax provision as such taxes are reflected in additional paid in capital. The
primary reason for the reduction in the valuation allowance in 1998 and 1997 was
the greater likelihood of the utilization of future tax benefits from net
operating loss carryforwards. Realization of deferred tax assets associated with
the NOL carryforwards is dependent upon the Company generating sufficient
taxable income prior to their expiration. Management believes that there is a
risk that certain of the state NOL carryforwards may expire unused and,
accordingly, has established a valuation allowance against them. Although
realization is not assured for the remaining deferred tax assets, management
believes it is more likely than not that they will be realized through future
taxable earnings. However, the net deferred tax assets could be reduced in the
future if management's estimates of taxable income during the carryforward
period are significantly reduced.
As of June 28, 1998, the Company has net operating loss carryforwards
for Federal purposes of $3,493,000 and $2,346,000 for state purposes. The
carryforward expiration period is 2011 to 2013 for Federal tax purposes and from
2000 to 2003 for state purposes.
43
10. ACQUISITION
In August 1994, the Company formed a North Carolina wholly-owned
subsidiary, RCD, to develop and market full color LED displays. Subsequently,
RCD acquired the net assets of Color Cells International, Ltd., a Hong-Kong
based company in this line of business, for cash consideration of $215,000 and
assumption of $152,000 of liabilities. The terms of the acquisition called for
an "Earn-Out Payment" based on calculated net profits, payable half in cash and
half in Cree common stock. Earn-Out Payments were subject to certain limitations
concerning the timing (calculation based on certain eligible shipments through
September 1997) and amount (maximum payments of $1.8 million) of any such
payments. As of the end of the earn-out period in September 1997, no amounts had
been earned or paid under this agreement.
11. RETIREMENT PLAN
The Company maintains an employee benefit plan (the "Plan") pursuant to
Section 401(k) of the Internal Revenue Code. Under the Plan, there is no fixed
dollar amount of retirement benefits, and actual benefits received by employees
will depend on the amount of each employee's account balance at the time of
retirement. All employees are eligible to participate under the Plan on the
first day of a new fiscal quarter after date of hire. The Plan is not insured by
the Pension Benefit Guaranty Corporation.
The Company may, at its discretion, make contributions to the Plan.
However, the Company did not make any contributions to the Plan during the years
ended June 28, 1998, June 30, 1997 or 1996.
12. CONTINGENCIES
The consolidated securities class action lawsuits previously pending
against the Company and certain of its directors and officers in the U.S.
District Court for the Middle District of North Carolina were dismissed with
prejudice on November 28, 1997. The dismissal was pursuant to a stipulation of
the named parties entered after the court granted the defendant's motions to
dismiss the consolidated complaint for failure to state a claim. No payments
were made to the plaintiffs to obtain the dismissal. By stipulating to the
dismissal with prejudice, the plaintiffs waived any right to re-file the action
or to appeal the court's order of dismissal.
13. EARNINGS PER SHARE
The Company has adopted Statement of Financial Accounting Standards
(SFAS) No. 128, "Earnings Per Share", as of December 28, 1997. SFAS No. 128
required the Company to change its method of computing, presenting and
disclosing earnings per share information. All prior period data presented has
been restated to conform to the provisions of SFAS No. 128.
The following computation reconciles the differences between the basic
and diluted presentations:
44
Year Ended
-------------------------------------
June 28, June 30, June 30,
1998 1997 1996
----------- ----------- ----------
Basic:
Net income $ 6,275,000 $ 3,542,000 $ 243,000
=========== =========== ==========
Weighted average common shares 12,862,917 12,455,494 11,825,857
=========== =========== ==========
Basic income per common share $ 0.49 $ 0.28 $ 0.02
=========== =========== ==========
Diluted:
Net income $ 6,275,000 $ 3,542,000 $ 243,000
=========== =========== ==========
Weighted average shares:
Common shares outstanding 12,862,917 12,455,494 11,825,857
Dilutive effect of stock options & warrants 630,533 670,048 789,107
----------- ----------- ----------
Total shares and common share equivalents 13,493,450 13,125,542 12,614,964
=========== =========== ==========
Diluted income per common share $ 0.47 $ 0.27 $ 0.02
=========== =========== ==========
14. NEW ACCOUNTING PRONOUNCEMENTS
The Company will adopt Statement of Financial Accounting Standards No.
130 "Reporting Comprehensive Income" ("SFAS No. 130") for the year ended June
27, 1999. SFAS No. 130 requires the Company to display an amount representing
total comprehensive income for the period in a financial statement which is
displayed with the same prominence as other financial statements. Upon adoption,
all prior period data presented will be restated to conform to the provisions of
SFAS No. 130. The application of the new pronouncement is not expected to have a
material impact on the Company's financial statements.
The Company will adopt Statement of Financial Accounting Standards No.
131 "Disclosures about Segments of an Enterprise and Related Information" ("SFAS
No. 131") for the year ended June 27, 1999. SFAS No. 131 requires the Company to
report selected information about operating segments in its financial
statements. It also establishes standards for related disclosures about products
and services, geographic areas, and major customers. The application of the new
pronouncement is not expected to have a material impact on the Company's
disclosures.
Item 9.Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure
None.
PART III
45
Item 10. Directors and Executive Officers
Item 11. Executive Compensation
Item 12. Security Ownership of Certain Beneficial Owners and Management
Item 13. Certain Relationships and Related Transactions
The information called for in items 10 through 13 is incorporated by reference
from the Company's definitive proxy statement relating to its annual meeting of
stockholders, which will be filed with the Securities and Exchange Commission
within 120 days after the end of fiscal 1998.
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) (1) and (2) Financial statements and financial statement schedule - the
financial statements, financial statements schedule, and report of independent
accountants are filed as part of this report (see index to Consolidated
Financial Statements at Part II Item 8 on page 23 of this Form 10-K).
(a) (3) The following exhibits have been or are being filed herewith and are
numbered in accordance with Item 601 of Regulation S-K:
Exhibit
No. Description
3.1 Articles of Incorporation, as amended to date
3.2 Bylaws, as amended to date
10.1 Amended and Restated Equity Compensation Plan of the
Company, as amended to date
10.2 Lease Agreements for Meridian Parkway facility dated
February 10, 1988, as amended from time to time through
August 25, 1992(1)
10.3 Amendments to Lease Agreements for the Meridian Parkway
facility dated April 12, 1993 and June 15, 1993(2)
10.3 License Agreement between the Company and North Carolina
State University dated December 3, 1987(1)
10.4 Amendment to License Agreement between the Company and
North Carolina State University dated September 11, 1989(1)
10.5 Agreement between General Instrument Corporation and the
Company dated June 24, 1988(1)
46
10.6 Letter Agreement with General Instrument Corporation dated
February 21, 1992, superseding agreement dated June 24,
1988(1)
10.7 Contract between the Company and Siemens A.G. dated
October 24, 1995(3)
10.8 Purchase Agreement between the Company and Siemens A.G.
dated September 11, 1996 (4)
10.9 License and Technology Transfer Agreement between the
Company and Shin- Etsu Handotai Co. Ltd dated September 30,
1996 (5)
10.10 Supply Agreement between the Company and Shin-Etsu
HandotaiCo. Ltd, dated September 30, 1996 (5)
10.11 First Amendment to Purchase Agreement between the Company
and Siemens A.G. dated April 22, 1997 (6)
10.12 Second Amendment to Purchase Agreement between the Company
and Siemens A.G. dated December 9, 1997 (7)
10.13 Agreement between the Company and F. Neal Hunter dated
December 28, 1997.
10.14 Amended and Restated Indemnity Agreement between the Company
and F. Neal Hunter dated June 26, 1998.
11.00 Computation of Per Share Earnings
21.00 Subsidiaries of Registrant
23.00 Consent of Independent Accountants
27.00 Financial Data Schedule (for SEC use only)
(1)Incorporated by reference herein. Filed as an exhibit to the Company's
Registration Statement filed on Form SB-2 and declared effective by the
Securities and Exchange Commission on February 8, 1993 and bearing Registration
#33-55998.
(2)Incorporated by reference herein. Filed as an exhibit to the Company's annual
report filed on Form 10-KSB with the Securities and Exchange Commission on
August 1, 1993.
(3)Incorporated by reference herein. Filed as an exhibit to the Company's
Registration Statement filed on Form S-3 (No. 33-98728) declared effective by
the Securities and Exchange Commission on December 27, 1995. Confidential
treatment of portions of this was granted by the Securities and Exchange
Commission pursuant to Rule 24 b-2 by order dated December 29, 1995.
(4)Incorporated by reference herein. Filed as an exhibit to the Company's
quarterly report filed on Form 10K with the Securities and Exchange Commission
on September 30, 1996. Confidential treatment of portions of this document was
granted by the Securities and Exchange Commission pursuant to Rule 24b-2 by
order dated November 21, 1996.
47
(5)Incorporated by reference herein. Filed as an exhibit to the Company's
quarterly report filed on Form 10Q with the Securities and Exchange Commission
on November 14, 1996. Confidential treatment of portions of this document was
granted by the Securities and Exchange Commission pursuant to Rule 24b-2 by
order dated February 3, 1997.
(6)Incorporated by reference herein. Filed as an exhibit to the Company's
quarterly report filed on Form 10Q with the Securities and Exchange Commission
on May 2, 1997. Confidential treatment of portions of this document was granted
by the Securities and Exchange Commission pursuant to Rule 24b-2 by order dated
June 26, 1997.
(7)Incorporated by reference herein. Filed as an exhibit to the Company's
quarterly report filed on Form 10Q with the Securities and Exchange Commission
on January 30, 1998. Confidential treatment of portions of this document was
granted by the Securities and Exchange Commission pursuant to Rule 24b-2 by
letter dated February 12, 1998.
(b) Reports on Form 8-K filed during the last quarter of the period covered
by this report. None.
48
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.
By: s/ F. Neal Hunter
-------------------------------------
F. Neal Hunter
Date: August 19, 1998 President and Chief Executive Officer
Pursuant to the requirements of the Securities and Exchange Act of
1934, this report has been signed below by the following persons on behalf of
the registrant and in the capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
s/F. Neal Hunter Chairman of the Board August 19, 1998
- -------------------------------
F. Neal Hunter
s/Cynthia B. Merrell Chief Financial Officer August 19, 1998
- -------------------------------
Cynthia B. Merrell
s/Calvin H. Carter, Jr., Ph. D. Director August 19, 1998
- -------------------------------
Calvin H. Carter, Jr., Ph.D.
s/James E. Dykes Director August 19, 1998
- -------------------------------
James E. Dykes
s/Michael W. Haley Director August 19, 1998
- -------------------------------
Michael W. Haley
s/Walter L. Robb, Ph.D. Director August 19, 1998
- -------------------------------
Walter L. Robb, Ph.D.
s/Dolph W. von Arx Director August 19, 1998
- -------------------------------
Dolph W. von Arx
s/John W. Palmour, Ph.D. Director August 19, 1998
- -------------------------------
John W. Palmour, Ph.D
49