SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 28, 1999
Commission file number: 0-21154
CREE RESEARCH, INC.
(Exact name of registrant as specified in its charter)
North Carolina 56-1572719
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
4600 Silicon Drive
Durham, North Carolina 27703
(Address of principal executive offices) (Zip Code)
(919) 313-5300
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. [ X] Yes [ ] No
The number of shares outstanding of the registrant's common stock, par value
$0.005 per share, as of April 7, 1999 was 14,505,689.
<PAGE>
CREE RESEARCH, INC.
FORM 10-Q
For the Quarter Ended March 28, 1999
INDEX
Page No.
--------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated balance sheets at March 28, 1999 (unaudited)
and June 28, 1998 3
Consolidated statements of income for the three and nine
months ended March 28, 1999 and March 29, 1998 (unaudited) 4
Consolidated statements of cash flows for the nine months
ended March 28, 1999 and March 29, 1998 (unaudited) 5
Notes to consolidated financial statements (unaudited) 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 11
Item 3. Quantitative and Qualitative Disclosures of Market Risk 19
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 20
SIGNATURES 21
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<PAGE>
PART I - FINANCIAL INFORMATION
Item 1 - Financial Statements
<TABLE>
CREE RESEARCH, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands)
<CAPTION>
March 28, June 28,
1999 1998
----------- ----------
(Unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 53,302 $ 17,680
Marketable securities -- 657
Accounts receivable, net 14,006 10,479
Inventories 3,880 2,543
Deferred income tax 264 1,952
Prepaid expenses and other current assets 837 1,347
----------- -----------
Total current assets 72,289 34,658
Property and equipment, net 56,171 36,476
Patent and license rights, net 1,654 1,525
Other assets 1,348 65
----------- -----------
Total assets $131,462 $ 72,724
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable, trade $ 4,840 $ 5,595
Current maturities of long term debt -- 17
Accrued salaries and wages 1,013 391
Other accrued expenses 2,007 1,052
----------- -----------
Total current liabilities 7,860 7,055
Long term liabilities:
Long term debt -- 8,650
Deferred income tax 2,477 2,154
----------- -----------
Total long term liabilities 2,477 10,804
Shareholders' equity:
Preferred stock, par value $0.01; 3,000 shares -- --
authorized at March 28, 1999 and 2,750 shares
authorized at June 28, 1998; none issued and
outstanding
Common stock, par value $0.005; 30,000 shares 73 65
authorized at March 28, 1999 and 14,500 shares
authorized at June 28, 1998; shares issued and
outstanding 14,505 and 12,989 at March 28, 1999
and June 28, 1998, respectively
Additional paid-in-capital 107,334 49,676
Retained earnings 13,718 5,124
----------- -----------
Total shareholders' equity 121,125 54,865
----------- -----------
Total liabilities and shareholders' equity $ 131,462 $ 72,724
=========== ===========
</TABLE>
The accompanying notes are an integral part of the
consolidated financial statements.
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<PAGE>
<TABLE>
CREE RESEARCH, INC.
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share data)
(Unaudited)
<CAPTION>
Three Months Ended Nine Months Ended
------------------------ -------------------------
March 28, March 29, March 28, March 29,
1999 1998 1999 1998
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Revenue:
Product revenue, net $14,084 $ 8,929 $37,609 $25,298
Contract revenue, net 1,951 1,742 4,743 5,685
---------- ---------- ---------- ----------
Total revenue 16,035 10,671 42,352 30,983
Cost of revenue:
Product revenue 6,794 5,510 18,586 15,875
Contract revenue 1,503 1,430 3,755 4,679
---------- ---------- ---------- ----------
Total cost of revenue 8,297 6,940 22,341 20,554
---------- ---------- ---------- ----------
Gross profit 7,738 3,731 20,011 10,429
Operating expenses:
Research and development 1,515 367 3,442 1,287
Sales, general and 1,568 1,041 4,236 3,026
administrative
Other expense 311 31 878 423
---------- ---------- ---------- ----------
Income from operations 4,344 2,292 11,455 5,693
Interest income, net 347 180 482 513
---------- ---------- ---------- ----------
Income before income 4,691 2,472 11,937 6,206
taxes
Income tax expenses 1,314 717 3,343 1,810
---------- ---------- ---------- ----------
Net income $ 3,377 $ 1,755 $ 8,594 $ 4,396
========== ========== ========== ==========
Earnings per share:
Basic $0.25 $0.13 $0.65 $0.34
========== ========== ========== ==========
Diluted $0.23 $0.13 $0.61 $0.33
========== ========== ========== ==========
</TABLE>
The accompanying notes are an integral part of the
consolidated financial statements.
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<PAGE>
<TABLE>
CREE RESEARCH, INC.
CONSOLIDATED STATEMENTS OF CASH FLOW
(In thousands)
<CAPTION>
Nine Months Ended
------------------------------
March 28, March 29,
1999 1998
------------- -------------
(Unaudited)
<S> <C> <C>
Operating activities:
Net income $8,594 $4,396
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization 3,679 3,125
Loss on disposal of property, equipment and 1,284 326
patents
Amortization of patent rights 86 75
Amortization and write off of goodwill -- 86
Proceeds from sale of marketable trading 1,421 421
securities
Purchase of marketable trading securities (234) (1,500)
(Gain) loss on marketable trading securities (141) 333
Changes in operating assets and liabilities:
Accounts receivable (3,862) (286)
Inventories (1,337) 1,373
Prepaid expenses and other assets 861 (201)
Accounts payable , trade (986) (699)
Accrued expenses 2,010 1,913
--------------- ------------
Net cash provided by operating activities 11,375 9,362
--------------- ------------
Investing activities:
Purchase of property and equipment (24,816) (9,346)
Proceeds from sale of property and equipment 189 463
Purchase of patent rights (246) (265)
--------------- ------------
Net cash used in investing activities (24,873) (9,148)
--------------- ------------
Financing activities:
(Retirement) proceeds of long-term debt (8,545) 4,378
Net proceeds from issuance of common stock 60,285 2,911
Receipt of Section 16(b) common stock 594 --
profits
Repurchase of common stock (3,214) (318)
--------------- ------------
Net cash provided by financing activities 49,120 6,971
--------------- ------------
Net increase in cash and cash equivalents 35,622 7,185
Cash and cash equivalents:
Beginning of period 17,680 10,448
=============== ============
End of period $ 53,302 $ 17,633
=============== ============
Supplemental disclosure of cash flow information:
Cash paid for interest, net amounts $ 387 $ 48
capitalized =============== ============
Cash paid for income taxes $1,563 $ 234
=============== ============
</TABLE>
The accompanying notes are an integral part of the
consolidated financial statements.
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<PAGE>
CREE RESEARCH, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Basis of Presentation
The consolidated balance sheet as of March 28, 1999, the consolidated statements
of income for the three and nine months ended March 28, 1999 and March 29, 1998,
and the consolidated statements of cash flow for the nine months ended March 28,
1999 and March 29, 1998 have been prepared by the Company and have not been
audited. In the opinion of management, all normal and recurring adjustments
necessary to present fairly the financial position, results of operations and
cash flow at March 28, 1999, and all periods presented have been made. The
balance sheet at June 28, 1998 has been derived from the audited financial
statements as of that date.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted. It is suggested that these condensed financial
statements be read in conjunction with the financial statements and notes
thereto included in the Company's fiscal 1998 Form 10-K. The results of
operations for the period ended March 28, 1999 are not necessarily indicative of
the operating results that may be attained for the entire fiscal year.
Accounting Policies
Fiscal Year
The Company's fiscal year is a 52 or 53 week period ending on the last Sunday in
the month of June. Accordingly, all quarterly reporting reflects a 13-week
period in fiscal 1999. In fiscal 1998, the Company changed its fiscal year from
the twelve months ending June 30, to the 52-week period ending on the last
Sunday in the month of June. The Company's current fiscal year will extend from
June 29, 1998 to June 27, 1999.
Investments
Investments are accounted for in accordance with Statement of Financial
Accounting Standards No. 115, "Accounting for Certain Investments in Debt and
Equity Securities" ("SFAS No. 115"). 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.
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<PAGE>
(c) Securities Available-for-Sale -- Debt and equity securities not
classified as either securities held-to-maturity or trading securities
are reported at fair value with unrealized gains and losses excluded
from earnings and reported as a separate component of stockholders'
equity.
As of March 28, 1999, the Company had no short-term investments. At June 28,
1998, all short-term investments were comprised of equity securities that were
classified as trading securities, which were 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 consisted of common stock holdings
in C3, Inc. ("C3"), the majority of which were bought in November 1997. The
Company also purchased additional shares of C3 in September 1998 and acquired
24,601 shares directly from C3 pursuant to the exercise of an option in January
1997. All common shares of C3 held by Cree were subsequently sold during the
second and third quarters of fiscal 1999. Realized gains on shares of C3 stock
sold by the Company were $13,000 and $140,000, for the three and nine months
ended March 28, 1999, respectively. These amounts were recorded as other income.
Approximately $32,000 of net loss was recorded to other income (expense) in
fiscal 1998.
Long Term Debt
As of March 28, 1999, the Company had paid-off the entire $10 million debt
associated with the term loan acquired in November 1997 from a commercial bank
to finance the purchase and upfit of a production facility. This loan, which was
collateralized by the purchased property, accrued interest monthly at a fixed
rate of 8% and carried customary covenants. Proceeds received from the secondary
stock offering were used to retire this debt on February 17, 1999.
During the three and nine months ended March 28, 1999, the Company capitalized
interest on funds used to construct property, plant and equipment in connection
with the facility. Interest capitalized for the three and nine months ended
March 28, 1999 was $9,000 and $128,000, respectively.
Inventories
Inventories are stated at the lower of cost or market, with cost determined
under the first-in, first-out (FIFO) method. Inventories consist of the
following:
<TABLE>
<CAPTION>
March 28, June 28,
1999 1998
------------ ------------
(In thousands)
<S> <C> <C>
Raw materials $ 1,383 $ 999
Work-in-progress 1,055 752
Finished goods 1,442 792
------------ ------------
Total Inventory $ 3,880 $ 2,543
============ ============
</TABLE>
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<PAGE>
Research and Development Accounting Policy
The U.S. Government provides funding for several of the Company's current
research and development efforts. The contract funding may be based on a
cost-plus or a cost-share arrangement. The amount of funding under each contract
is determined based on cost estimates that include direct costs, plus an
allocation for research and development, general and administrative and cost of
capital expenses. Cost-plus funding is determined based on actual costs plus a
set percentage margin. For cost-share contracts, the actual costs are divided
between the U.S. Government and the Company based on the terms of the contract.
The government's cost share is then paid to the Company. Activities performed
under these arrangements include research regarding silicon carbide and gallium
nitride materials. The contracts typically require submission of a written
report to document the results of such research.
The revenue and expense classification for contract activity is determined based
on the nature of the contract. For contracts where the Company anticipates that
funding will exceed direct costs over the life of the contract, funding is
reported as contract revenue and all direct costs are reported as costs of
contract revenue. For contracts under which the Company anticipates that direct
costs will exceed amounts to be funded over the life of the contract, costs are
reported as research and development expenses and related funding as an offset
of those expenses.
In the second quarter of fiscal 1998 all funding under contracts where the
Company anticipated that direct costs would exceed amounts to be funded had been
exhausted. Therefore, all funding has been recorded as contract revenue while
all direct costs are reported as costs of contract revenue for the three and
nine months ended March 28, 1999 and for the three months ended March 29, 1998.
For the nine months ended March 28, 1998, approximately $1,427,000 of contract
funding had been recorded as an offset to research and development expenses.
Significant Sales Contract
In September 1996, the Company entered into a Purchase Agreement with Siemens AG
("Siemens"), pursuant to which Siemens agreed to purchase LED chips made with
the Company's gallium nitride-on-silicon carbide technology. In April 1997 and
December 1997, contract amendments were executed that provided for enhanced
product specifications requested by Siemens and larger volume requirements,
respectively.
In September 1998, the Company and Siemens further amended the contract to
extend the Purchase Agreement with respect to shipments to be made on or after
June 29, 1998. The third amendment obligates the Company to ship, and Siemens to
purchase stipulated quantities of both the conductive buffer and the new high
brightness LED chips and silicon carbide wafers through fiscal 1999. The
agreement also limits Siemens' right to defer shipments to 30% of scheduled
quantities for items to be shipped in more than 24 weeks after initial notice
and 10% of scheduled quantities for items to be shipped in more than 12 weeks
after initial notice. In both cases, Siemens would be required to accept all
products within 90 days of the original shipment date. Additionally, the
amendment provides for higher per unit prices early in the contract with
reductions in unit prices as the cumulative volume shipped increases.
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<PAGE>
In December 1998, the Company and Siemens further amended the contract to
include greater quantities of conductive buffer LED chips to be shipped during
fiscal 1999 and to extend the contract for these shipments through September
1999. This amendment also provides for higher per unit prices early in the
contract with reductions in unit prices as the cumulative volume shipped
increases. As was the case with the third amendment, these higher prices were
negotiated by the Company to offset higher per unit costs expected earlier in
the contract.
Income Taxes
The Company has established an estimated tax provision based upon an effective
rate of 28% for fiscal 1999. The estimated tax rate was based on tax reduction
strategies being implemented by the Company. The estimated effective rate was
based upon projections of income for the fiscal year and the Company's ability
to utilize remaining net operating loss carryforwards and other tax credits.
However, the actual effective rate may vary depending upon actual pre-tax book
income for the year or other factors.
Earnings Per Share
The Company presents earnings per share in accordance with Statement of
Financial Accounting Standards No. 128, "Earnings Per Share" ("SFAS 128"). SFAS
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 128. The following
computation reconciles the differences between the basic and diluted
presentations:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
March 28, March 29, March 28, March 29,
1999 1998 1999 1998
--------- --------- ---------- ----------
(In thousands, except per share amounts)
<S> <C> <C> <C> <C>
Net income $ 3,377 $ 1,755 $ 8,594 $ 4,396
Weighted average common shares 13,633 13,028 13,129 12,808
--------- --------- --------- ---------
Basic earnings per common share $ 0.25 $ 0.13 $ 0.65 $ 0.34
========= ========= ========= =========
Net income $ 3,377 $ 1,755 $ 8,594 $ 4,396
Diluted weighted average common
shares:
Common shares outstanding 13,633 13,028 13,129 12,808
Diluted effect of stock options 1,252 473 860 707
and warrants --------- --------- --------- ---------
Total diluted weighted average 14,885 13,501 13,989 13,515
common shares --------- --------- --------- ---------
Diluted earnings per common share $ 0.23 $ 0.13 $ 0.61 $ 0.33
========= ========= ========= =========
</TABLE>
Potential common shares that would have the effect of increasing diluted income
per share are considered to be antidilutive. In accordance with SFAS 128, these
common shares were not included in calculating diluted income per share. As of
March 28, 1999, there were no potential shares considered to be antidilutive.
For the three and nine months ended March 29, 1998, there were 360,000 shares
that were not included in calculating diluted income per share because the
effect was antidilutive.
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<PAGE>
Shareholders' Equity
On February 17, 1999, the Company completed a secondary public offering selling
1,495,000 shares of its common stock at a price of $39.38 per share. The Company
received net aggregate proceeds of approximately $55.3 million after deducting
underwriting discounts and commissions and estimated offering costs. The net
proceeds will be used primarily for future plant expansion needs; however, $10
million has been used to repay outstanding debt to a commercial bank.
New Accounting Pronouncements
In fiscal 1999, the Company adopted Statement of Financial Accounting Standards
No. 130, "Reporting Comprehensive Income" ("SFAS 130"), which establishes
standards for reporting and display of comprehensive income and its components
in a full set of general-purpose financial statements. SFAS 130 only impacts
financial statement presentation as opposed to actual amounts recorded. Other
comprehensive income includes all nonowner changes in equity that are excluded
from net income. This Statement has no financial statement impact for an
enterprise that has no items of other comprehensive income in any period
presented. During the three and nine months ended March 28, 1999 and March 29,
1999, the Company had no items of other comprehensive income.
In fiscal 1999, the Company adopted Statement of Financial Accounting Standards
No. 131, "Disclosures about Segments of an Enterprise and Related Information"
("SFAS 131"). SFAS 131 changes the way public companies report segment
information in annual financial statements and also require those companies to
report selected segment information in interim financial statements to
shareholders. SFAS 131 also establishes standards for related disclosures about
products and services, geographic areas, and major customers. The application of
the new rules does not have a significant impact on the Company's financial
statements.
In June 1998, the Financial Accounting Standards Board issued Statement No. 133,
"Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133"),
which is required to be adopted in years beginning after June 15, 1999. Because
of the Company's minimal use of derivatives, management does not anticipate that
the adoption of the new Statement will have a significant effect on earnings or
the financial position of the Company.
Subsequent Event
On May 6, 1999, the Company entered into a development agreement with
Microvision, Inc. ("MVIS") for research directed at the development of
edge-emitting LEDs and laser diodes. MVIS has committed to fund a total of
$2,600,000, or $650,000 payable quarterly, to Cree for one year commencing on
May 6, 1999. This agreement is extendable at MVIS' option for a second year for
an additional commitment of $2,500,000. During the initial term, Cree commits to
spend at least $225,000 per quarter for LED objectives. If the costs incurred by
Cree toward the program objectives in any fiscal quarter are less than $650,000
or a portion of costs incurred in any fiscal quarter toward LED objectives are
less than $225,000, the initial term will be
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<PAGE>
extended for a number of weeks equal to the funding deficit for the year. All
costs incurred under the program will be charged as research and development
expenses with related funding offsetting these costs. To secure payment of the
development fees, MVIS has provided Cree an irrevocable documentary letter of
credit issued by a domestic commercial bank. Several milestones have been
identified in the development agreement. Cree is obligated to use best efforts
to achieve all milestones; however, Cree is not obligated to incur costs in
excess of funding paid under the agreement. Failure to achieve milestones will
not be grounds for termination of the agreement or to withhold payment of the
development fee. Cree has no liability for the failure to achieve any milestone.
Any funding received by Cree is nonrefundable. Cree has also granted exclusive
rights to MVIS for use of products developed in the program in scanned beam
applications for three years after the termination of the agreement (or six
years if the extension option is exercised).
On May 6, 1999, the Company purchased 268,600 shares of common stock of
Microvision, Inc ("MVIS") in a private equity transaction. The price paid was
calculated based on the volume weighted average of the intraday high-low mean
for the ten trading days preceding closing or approximately $16.75 per share.
MVIS is required to file a registration statement to register these shares
within 90 days of the closing. In addition, Cree has agreed not to sell the
shares until at least January 6, 2000. Cree will account for its investment in
MVIS under FAS 115 as an "available for sale" security.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Information set forth in this Form 10-Q, including Management's Discussion and
Analysis of Financial Condition and Results of Operations, contains various
"forward-looking statements" within the meaning of Section 27A of the Securities
Act of 1933 and Section 21E of the Securities Act of 1934. These statements
represent the Company's judgment concerning the future and are subject to risks
and uncertainties that could cause the Company's actual operating results and
financial position to differ materially. Such forward-looking statements can be
identified by the use of forward-looking terminology such as "may," "will,"
"anticipate," "believe," "plan," "estimate," "expect," and "intend" or the
negative thereof or other variations thereof or comparable terminology. The
Company cautions that any such forward-looking statements are further qualified
by important factors that could cause the Company's actual operating results to
differ materially from those in the forward-looking statements. These statements
include, but are not limited to, fluctuations in our operating results,
production yields in our manufacturing processes, whether we can produce
commercial quantities of high brightness blue and green LEDs, our dependence on
a few customers, whether we can manage our growth effectively, assertion of
intellectual property rights by others, adverse economic conditions, and
insufficient capital resources. See Exhibit 99.1 for additional factors that
could cause the Company's actual results to differ.
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<PAGE>
Overview
Cree Research, Inc. is the world leader in developing and manufacturing
semiconductor materials and electronic devices made from silicon carbide
("SiC"). We derive the largest portion of our revenue from the sale of blue and
green light emitting diode ("LED") products. The Company offers LEDs at two
brightness levels -- high brightness blue and green products and standard blue
products. The high brightness products, which were introduced to the market in
September 1998 in limited quantities, are currently being integrated into our
manufacturing facility for full production. During the first nine months of
fiscal 1999, margins realized on the high brightness products were substantially
lower than those derived from our standard blue LED product as the yield was
lower than the standard product. Historically, we have experienced low margins
with many new product introductions, and we are working to make improvements to
output and yield during the fourth quarter of fiscal 1999. We believe that in
order to increase market demand for all of our LED products, we must continue to
substantially lower average sales prices. Historically, we have been successful
in achieving lower costs for the standard blue product. During the remainder of
fiscal 1999, we plan to focus on reducing costs through higher production yields
and from higher volumes as fixed costs are spread over a greater number of
units.
We derive additional revenue from the sale of advanced materials made from SiC
that are used primarily for research and development. We also sell SiC crystals
to C3, which incorporates them in gemstone applications. The balance of our
revenue is derived from government contract funding. Under various programs,
U.S. Government entities provide funding to aid development of our technology.
On September 24, 1997, the Board of Directors 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 from July
1, 1997 to June 28, 1998.
Results of Operations
Three Months Ended March 28, 1999 and March 29, 1998
Revenue. Revenue grew 50% from $10.7 million in the third quarter of fiscal 1998
to $16.0 million in the third quarter of fiscal 1999. This increase resulted
from a 58% rise in product revenue from $8.9 million in the third quarter of
fiscal 1998 to $14.1 million in the third quarter of fiscal 1999. Higher product
revenue was primarily the result of a 175% increase in unit sales of our LED
products in the third quarter of fiscal 1999 compared to the third quarter of
fiscal 1998. This higher volume was somewhat offset by a 38% decline in the
average LED sales price received from customers in the third quarter of fiscal
1999 compared with the same period in fiscal 1998. The overall growth in LED
volume resulted from strong demand for the standard brightness product and an
increased customer base. By significantly lowering the average sales price for
LED products, Cree was able to meet customer price points for several new LED
applications, which continues to drive additional volume sold. Volume growth and
declining average sales prices for the standard brightness product are expected
to continue over the next
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<PAGE>
several quarters. While the high brightness production was almost three times
greater than units produced in the second quarter of fiscal 1999, these products
are not yet fully integrated into our manufacturing process. Although the yield
for the high brightness product continues to improve, additional progress will
be necessary to meet demand and improve gross margin.
Revenue attributable to sales of SiC materials was 47% higher in the third
quarter of fiscal 1999 than in the same period of fiscal 1998. This greater
revenue was a result of increased demand for gemstone materials from C3. C3
funded additional capacity at our manufacturing facility in early fiscal 1999,
and as a result revenue from sales of gemstone materials increased. Also,
revenue from our wafer business grew 23% from the third quarter of fiscal 1998
to the third quarter of fiscal 1999 due to a 24% rise in the number of wafers
sold. This increase was caused by a greater acceptance of silicon carbide in the
research community and improved product quality. The Company believes that
growth in future wafer sales may be slowed as more customers approach the
Company for device products rather than wafer materials. This trend is
indicative of the Company's special expertise in silicon carbide materials and
its success in the development of devices made from those materials. Contract
revenue received from U.S. Government agencies increased 12% during the third
quarter of fiscal 1999 compared to the third quarter of fiscal 1998 due to a
significant funding award that was made in the third quarter of fiscal 1999 for
microwave development.
Gross Profit. Gross margin climbed to 48% of revenue during the third quarter of
fiscal 1999 as compared to 35% during the third quarter of fiscal 1998. This
increase is predominantly attributable to design and manufacturing improvements
that occurred over the past year resulting in significant reductions in cost.
With the introduction of the new conductive buffer LED technology in the fourth
quarter of fiscal 1998, we were able to significantly lower costs of production
due to the fewer manufacturing steps required with the new chip structure and
improved yield. These cost reductions have more than offset declines in the
average sales prices of products, primarily LEDs. Wafer costs for SiC material
sales also declined 53% during the third quarter of fiscal 1999 over the
comparative period due to higher throughput and improved yield. Gross profit in
the third quarter of fiscal 1998 was also lower as over $0.4 million of
write-downs to inventory were made for the displays business, which has
subsequently been de-emphasized.
Research and Development. Research and development expenses increased 313% in
the third quarter of fiscal 1999 to $1.5 million from $0.4 million in the third
quarter of fiscal 1998. Much of this increase was caused by significantly higher
costs for the development of the new high brightness LED products. We anticipate
that internal funding for the development of new products will continue to grow
in future periods.
Sales, General and Administrative. Sales, general and administrative expenses
increased 51% in the third quarter of fiscal 1999 to $1.6 million from $1.0
million in the third quarter of fiscal 1998 due to the general growth of the
business. Also, as a result of our increased profitability during the third
quarter of fiscal 1999 over the third quarter of fiscal 1998, the profit sharing
accrual (which is based on 5% of net income) has also grown by $0.1 million. We
anticipate that total sales, general and administrative costs will continue to
increase in connection with the
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<PAGE>
growth of our business; however, we believe that as a percentage of revenue they
will remain constant or possibly decline.
Other (Income) Expense. Other expenses have increased 903% to $0.3 million
during the third quarter of fiscal 1999. In the third quarter of fiscal 1999, we
realized impairments to leasehold costs as a result of management's decision to
move equipment from our leased facility to our new manufacturing site. There
were no write-down charges taken in the third quarter of fiscal 1998.
Interest Income, Net. Interest income, net has increased 93% to $0.3 million in
the third quarter of fiscal 1999 from $0.2 million in the third quarter of
fiscal 1998 due to the completion of our secondary common stock offering in
February 1999. As a result of this offering, the Company raised net proceeds of
$55.3 million and issued 1.5 million shares of stock. With the proceeds from
this offering, we have been able to maintain a larger balance of cash on hand
and therefore realize greater interest income. Cree used a portion of the
proceeds to pay-off outstanding debt of $10 million; however, interest expense
recorded for the third quarter of fiscal 1999 was still higher than interest
expense in the third quarter of fiscal 1998 as a significant portion of that
interest was capitalized.
Income Tax Expense. Income tax expense for the third quarter of fiscal 1999 was
$1.3 million compared to $0.7 million in the third quarter of fiscal 1998. This
increase resulted from increased profitability during the third quarter of
fiscal 1999 over the same period of fiscal 1998.
Nine Months Ended March 28, 1999 and March 29, 1998
Revenue. Revenue grew 37% from $31.0 million in the first nine months of fiscal
1998 to $42.4 million in the first nine months of fiscal 1999. This increase was
attributable to higher product revenue, which grew 49% from $25.3 million in the
first nine months of fiscal 1998 to $37.6 million in the first nine months of
fiscal 1999. This rise in product revenue was a result of the 166% increase in
unit sales of our LED products in the first nine months of fiscal 1999 compared
to the first nine months of fiscal 1998. This higher volume was somewhat offset
by a 39% decline in the average LED sales price received from customers in the
first nine months of fiscal 1999 compared with the same period in fiscal 1998.
The majority of the growth in LED volume resulted from strong demand for the
standard brightness product and an increased customer base. By significantly
lowering the average sales price for LED products, Cree was able to meet
customer price points for several new LED applications, which continues to drive
additional volume sold. Volume growth and declining average sales prices for the
standard brightness product are expected to continue over the next several
quarters. The high brightness LED production, which began in the first quarter
of fiscal 1999, has contributed a 9% increase in volume for the first nine
months of fiscal 1999 over the prior year. These products are currently not yet
fully integrated into our manufacturing process. Although the yield for the high
brightness product continues to improve, additional progress will be necessary
to meet demand and improve gross margin.
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<PAGE>
Revenue attributable to sales of SiC material was 69% higher in the first nine
months of fiscal 1999 than in the same period of fiscal 1998 due to a
significant increase in sales to C3 for gemstone applications. During the first
nine months of fiscal 1998, C3 was in initial stages of operation; therefore,
unit sales were limited. C3 also funded additional capacity at our manufacturing
facility in early fiscal 1999, and as a result revenue from sales of gemstones
increased. Also, sales of SiC wafers increased 38% in the first nine months of
fiscal 1999 as compared to the first nine months of fiscal 1998, due to quality
improvements in wafers, along with the availability of the larger two-inch wafer
during fiscal 1999. During the first nine months of fiscal 1999, sales from our
displays business declined 96% over the prior year period as we have chosen to
de-emphasize this product line. Contract revenue received from U.S. Government
agencies declined 17% during the first nine months of fiscal 1999 compared to
the first nine months of fiscal 1998, as a significant contract that funded
optoelectronic research was exhausted in early fiscal 1999. However, a new
significant microwave contract has been funded in the third quarter of fiscal
1999.
Gross Profit. Gross margin climbed to 47% of revenue during the first nine
months of fiscal 1999 as compared to 34% during the first six months of fiscal
1998. This increase is predominantly attributable to design and manufacturing
improvements that occurred over the past year resulting in significant
reductions in cost. With the introduction of the new conductive buffer LED
technology in the fourth quarter of fiscal 1998, we were able to significantly
lower costs of production due to fewer manufacturing steps required with the new
chip structure and improved yield. During the first nine months of fiscal 1998,
we introduced a smaller LED chip size and, in December 1997, we began to
fabricate devices on a larger two-inch wafer. For much of fiscal 1998, we were
still in the process of establishing these new manufacturing designs and had not
achieved production efficiency. In addition, the larger two-inch wafer had not
been in full production for much of the period; therefore, average die yields
during the first nine months of fiscal 1998 were significantly lower. Wafer
costs for SiC material sales also declined 53% during the first nine months of
fiscal 1999 over the comparative period due to more efficient processes and
higher volume throughput. The Company believes that growth in future wafer sales
may be slowed as more customers approach the Company for device products rather
than wafer materials. This trend is indicative of the Company's special
expertise in silicon carbide materials and its success in the development of
devices made from those materials. Gross profit for the first nine months of
fiscal 1998 was also lower as $0.4 million of write-downs to inventory were made
for the displays business, which has subsequently been de-emphasized.
Research and Development. Research and development expenses increased 167% in
the first nine months of fiscal 1999 to $3.4 million from $1.3 million in the
first nine months of fiscal 1998. Much of this increase was caused by
significantly higher costs for the development of the new high brightness LED
product. We anticipate that internal funding for the development of new products
will continue to grow in future periods.
Sales, General and Administrative. Sales, general and administrative expenses
increased 40% in the first nine months of fiscal 1999 to $4.2 million from $3.0
million in the first nine months of fiscal 1998 due primarily to the overall
growth in our business. In addition, during the second quarter of fiscal 1998,
Cree expenses benefited from two one-time insurance refunds. As a result
-15-
<PAGE>
of the dismissal of a securities class action lawsuit in November 1997, Cree was
reimbursed $0.2 million for costs incurred in connection with the lawsuit. Most
of these expenses were recorded in fiscal 1997. In addition, we received a $0.2
million reimbursement of medical expenses due to a negotiated cost cap in a
partially self-funded insured health plan. As a result of our increased
profitability during the first nine months of fiscal 1999 over the first nine
months of fiscal 1998, the profit sharing accrual (which is based on 5% of net
income) has also grown by $0.3 million. We anticipate that total sales, general
and administrative costs will increase in connection with the growth of our
business; however, we believe that as a percentage of revenue they will remain
constant or possibly decline.
Other (Income) Expense. Other expenses have increased 108% to $0.9 million
during the first nine months of fiscal 1999 from $0.4 million for the first nine
months of fiscal 1998 due to higher write-downs of fixed assets. In the first
nine months of fiscal 1999, we realized impairments to leasehold costs as a
result of management's decision to move equipment from our leased facility to
our new manufacturing site.
Interest Income, Net. Interest income, net has decreased 6% to $0.5 million in
the first nine months of fiscal 1999 from $0.5 million in the first nine months
of fiscal 1998 due to interest expense incurred and lower cash balances
maintained for a majority of the nine months ended March 28, 1999. The
completion of our secondary common stock offering in February 1999 provided
$55.3 million; however, for the majority of the nine-month period, these
proceeds were not included in investible cash balances. Cree used a portion of
the proceeds to pay-off outstanding debt of $10 million; however, interest
expense recorded for the first nine months of fiscal 1999 was still higher than
interest expense in the third quarter of fiscal 1998. A significant portion of
interest incurred in fiscal 1998 was capitalized.
Income Tax Expense. Income tax expense for the first nine months of fiscal 1999
was $3.3 million compared to $1.8 million in the first nine months of fiscal
1998. This increase resulted from increased profitability during the first nine
months of fiscal 1999 over fiscal 1998. Our effective tax rate during the first
nine months of fiscal 1999 was 28% compared to 29% in the first nine months of
fiscal 1998.
Liquidity and Capital Resources
We have funded our operations to date through sales of equity, bank borrowings
and revenue from product and contract sales. On February 17, 1999, the Company
completed an underwritten secondary public offering of its common stock in which
the Company sold 1,495,000 new shares sold at a price of approximately $39.38
per share. There were no selling shareholders. The Company received net
aggregate proceeds from the secondary offering of approximately $45.3 million
after deducting underwriting discounts and commissions and estimated offering
costs and the payoff of long term debt. The Company expects that the majority of
these funds will continue to be used to expand facilities and equipment capacity
for the manufacturing plant in Durham, North Carolina. The remainder will be
used for general corporate purposes, including working capital. A portion of the
net proceeds may also be used to acquire or invest in complementary businesses.
Although the Company from time to time evaluates potential acquisitions of and
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<PAGE>
investments in such businesses and anticipates continuing to make such
evaluations, the Company has no present commitments or agreements with respect
to the acquisition of or investment in another business other than the equity
purchase of MVIS. Pending such uses, the proceeds will be invested in short-term
interest bearing securities and other instruments in compliance with the
Company's investment policy. As of March 28, 1999, we had working capital of
approximately $64.4 million, including $53.3 million in cash and cash
equivalents.
Operating activities generated $11.4 million in cash during the first nine
months of fiscal 1999. This was attributable primarily to net income of $8.6
million and other non-cash expenses of $5.0 million. These amounts were partly
offset by an increase of $3.9 million in account receivables, a $1.3 million
rise in inventory and a $1.0 million decrease in accounts payable. Cash also
increased by $2.0 million relating to a rise in accrued expenses. Cash generated
by operating activities for the nine months ended March 29, 1998 was $9.4
million. Cash was generated primarily from net income of $4.4 million and other
non-cash expenses of $3.6 million. Operating activities in the first nine months
of fiscal 1998 also benefited from a $1.4 million reduction in inventory and a
$1.9 million increase in accrued expenses.
The majority of the $24.8 million of cash used by investing activities in the
first nine months of fiscal 1999 was related to expenditures associated with the
continued construction of our new manufacturing facility in Durham, North
Carolina and equipment capacity increases made throughout the plant. We have
spent approximately $5.0 million for the new clean room facility, which was
completed in April 1999. We also increased manufacturing capacity by adding new
equipment to support the epitaxial deposition and crystal growth processes. In
February, Cree acquired an 80-acre tract of land near our existing facility for
$1.5 million. This land will provide expansion capabilities for future growth,
including providing space for a second manufacturing facility at a remote site.
We are currently expanding our facility for new crystal growth and test and
packaging areas. These additions will allow the Company to consolidate all LED
and wafer manufacturing facilities to one site. Approximately $5-8 million of
additional expenditures are expected to complete these projects. In addition, in
order to meet anticipated growth in LED and wafer sales and provide expanded
facilities for our new microwave product line; the Company anticipates a second
phase of expansion to facilities and equipment to begin in early fiscal 2000. We
anticipate total costs for these expenses to be between $15 and $18 million.
The $49.1 million of cash provided by financing activities in the first nine
months of fiscal 1999 related primarily to the proceeds from the secondary
public offering and exercises of stock warrants and stock options from the
Company's employee stock option plan. These cash proceeds were offset by a net
$8.5 million outflow for the pay-off of long-term debt to a commercial bank (the
$10.0 million balance less $1.5 million received in early fiscal 1999 from the
commercial bank) and a $3.2 million cash outlay for the repurchase of our common
stock. This stock was repurchased at an average price of $13.68. The stock
warrants exercised was distributed in connection with the Company's September
1995 private placement and had an exercise price of $27.23. As of March 28,
1999, warrants remained outstanding to purchase 147,750 shares; these warrants
will expire in September 2000.
-17-
<PAGE>
The Company believes that existing cash, along with cash generated from
operations, will be sufficient to meet the Company's capital requirements for at
least the next twelve months.
Impact of the Year 2000
State of Readiness
We have adopted a Year 2000 compliance plan and formed a team of information
technology professionals assigned the task of identifying and resolving any Year
2000 issues that may affect our business. Our compliance plan had four phases:
inventory, assessment, remediation and testing. We have now completed all phases
including a complete inventory for all of our computer systems; computer related
equipment and equipment with embedded processors, as well as our products. We
have completed the assessment with respect to all of our systems and have
determined that our products are of a nature that they are not subject to
failure as a result of Year 2000 issues. All necessary repairs and testing
needed to ready systems for Year 2000 compliance is completed. Although we
cannot control whether and how third parties will address the Year 2000 issue,
we also are in the process of contacting critical vendors and suppliers to
assess their ability to ensure smooth delivery of products without disruptions
caused by Year 2000 problems.
Costs
We have not prepared estimates of costs to remediate Year 2000 problems;
however, based on the results of our assessment of systems, we do not believe
that the costs associated with Year 2000 compliance will have a material adverse
effect on our business, results of operations or financial condition.
Year 2000 Risks
Although we believe that our Year 2000 compliance plan is adequate to address
Year 2000 concerns, there can be no assurance that we will not experience
negative consequences as a result of undetected defects or the non-compliance of
third parties with whom we interact. Furthermore, there can be no assurance 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. If
realized, these risks could result in an adverse effect on our business, results
of operations and financial condition.
We believe that our greatest risk stems from the potential non-compliance of our
suppliers. We depend on a limited number of suppliers for certain raw materials,
components and equipment necessary for the manufacture of our products.
Accordingly, if those suppliers are unable to process or fill our orders or
otherwise interact with us because of Year 2000 problems, we could experience
material adverse effects to our business. We are in the process of assessing the
Year 2000 status of our suppliers and are investigating alternative sources of
supply. As a consequence of our dependence on limited sources of supply, we
generally maintain a significant inventory of certain critical materials and
require suppliers to keep certain amounts of inventory
-18-
<PAGE>
available for us; however, there can be no assurance that we will have enough
materials on hand to continue production without interruption in the event one
or more of our suppliers experiences Year 2000 problems that affect its (their)
ability to supply us. Any supply chain disruptions would affect our ability to
manufacture our products, which could result in material adverse consequences to
our business, results of operations and financial condition.
Contingencies
We have not yet developed a contingency plan to address what would happen in the
event that we are unable to address the Year 2000 issue. The contingency plan
will be addressed after the inquiry of vendors and customers is completed.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
As of March 28, 1999, the Company had no investments in equity securities;
however, on May 6, 1999, the Company acquired an equity position in MVIS and
will therefore continue to experience a market risk for equity price change. In
addition, the $10 million term loan from a commercial bank, which accrued
interest at 8%, has been repaid as of February 17, 1999. Therefore, the Company
is no longer subject to market risk for interest rates.
-19-
<PAGE>
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit Description
27 Financial Data Schedule
99.1 Risk Factors (1)
(b) Reports on Form 8-K
No reports on Form 8-K were filed by the Company during the
quarter ended March 28, 1999.
- -------------------------------
(1) Incorporated by reference herein. Filed as an exhibit to the Company's
quarterly report filed on Form 10-Q with the Securities and Exchange Commission
on January 28, 1999.
-20-
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned thereunto duly authorized.
CREE RESEARCH, INC.
Date: May 11, 1999 /s/ Cynthia B. Merrell
--------------------------------------------
Cynthia B. Merrell
Chief Financial Officer and Treasurer
(Authorized Officer and Chief Financial
and Accounting Officer)
-21-
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